Federal Open Market Committee - Another Headache for the Fed?

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Fed Changes Tact in Forward Guidance
The first Federal Open Market Committee (FOMC) meeting under Janet Yellen’s leadership brought a much anticipated format change in communication policy, as well as a widely discounted $10bn reduction in monthly asset purchases. There was also abolition of the so-called Evans Rule, which allowed some overshooting of the Fed’s 2% long-term inflation target. Despite the new Fed Chair trying her utmost to portray the policy outlook as dovish, financial markets were not entirely convinced. Altering forward guidance was always going to be the biggest challenge in 2014, particularly given the faster-than-anticipated decline in unemployment. Policy thresholds have been abolished.
The emphasis of forward guidance has now shifted towards how long rates will remain low. New economic projections were released by the FOMC. The salient revision to the forecasts was the expected decline in unemployment to 6.1%-6.3% by 2014 Q4, taking it below the old threshold. The policy thresholds were not, however, an automatic trigger for higher interest rates. The overwhelming opinion of FOMC members (including non-voting) see policy firming to 1% by the end of 2015 and to between 2%-3% by December 2016. The normal federal funds rate is deemed to be 4%. Financial markets viewed these policy rate forecasts in a hawkish manner. Although short-term interest rates are expected to remain low (that is, below 4%), they will become increasingly more distant from zero. This is what spooked financial markets.
Botched Communication, But Inflation Becomes More Important
While the majority of the FOMC believes policy firming is appropriate by the end of 2015, there is still no official position on the timing of the first increase ...

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...ns about the post-Great Recession world. This is, however, potentially undermined by low conviction in its own economic forecasts. The Fed is also trying to keep as much policy flexibility as possible by keeping guidance ambiguous.
The Minneapolis Fed President was the sole dissenter at the last FOMC by claiming that the Fed’s 2% inflation target had been undermined. Additionally, he claims that ambiguity on guidance would result in greater risk-aversion.
Interest rates will remain low for a considerable period ahead, raising the spectre of financial bubbles. Financial stability has become a consideration for monetary policy. The Fed is monitoring conditions in the high yield corporate bond and leveraged loans markets. It is also looking at ways to reduce systemic financial instability by slowing growth during economic upswings to prevent excessive risk-taking.

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