U.S. Interest Rates Will Stay Low Until Late 2014

Highlights: Bernanke news conference on Fed policy

The Committee expects to maintain a highly accommodative stance for monetary policy, the Federal Open Market Committee said in a statement released in Washington today.

“Economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014,” says Fed chairman, Ben Bernanke.

The Fed extended its previous pledge to keep rates low at least until the middle of 2013 as more than two years of economic growth have failed to push unemployment below 8.5 percent. Fed officials in a separate statement today lowered their forecasts for economic growth and inflation this year and in 2013.

 1. Summary - The FOMC sees somewhat lower growth and inflation over the next couple of years. As a consequence, it thinks that rates will remain near zero at least until late 2014 (vs. mid-2013 before). The language of the statement and Bernanke's words in the press conference suggest that the odds of QE3 are increasing, although QE3 remains data dependent. The FOMC also adopted an inflation target of 2%. 
 
2. Growth outlook - The Committee expects growth to be "modest" over coming quarters. In Fed speak, this is a downgrade from "moderate," which was used previously. This change was reflected in the downward revision of the real GDP growth forecast and contrasts with most private sector projections, which have been revised up. The unemployment rate "remains elevated" and projections were adjusted downward only marginally. 
 
3. Inflation outlook - The statement said "inflation has been subdued." That's also a downgrade from "inflation has moderated," which the Fed used before. The FOMC set an inflation target of 2%, which should help anchor inflation expectations. However, it sees inflation below 2% in 2012, which suggests that there might be some concerns that deflation risks may be reemerging. 
 
4. Fed funds rate outlook - For the first time, along with its economic forecasts, the Fed provided FOMC participants' outlook for the federal funds rate. Out of 17 FOMC participants, 11 see the first rate hike in 2014 or later and six in 2015 or 2016. Six other participants would like to tighten policy in 2012 or 2013, but they most likely cannot sway the policy outcome since most of them are likely not voting members. As the statement said, the majority of the FOMC voting members sees rates near zero at least through late 2014.
 
5. Policy stance - The FOMC intends to keep rates near zero for longer than markets had expected, and that is thus a policy easing. The FOMC elected to keep the Fed's balance sheet constant, but noted that it "is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability." This suggests that if there is a revision to the size of the balance sheet it will be to the upside - i.e., QE3 might be in the cards.
 
6. Dissent - Not surprisingly given his previously expressed views, Richmond Fed President Lacker was the only dissenter at this meeting because he did not favor including language on the timing of keeping rates low at least through late 2014. 
 
7. Looking ahead - As Bernanke noted in the press conference, QE3 is data dependent. However, the fact that the growth outlook was downgraded, that inflation is seen as below target this year, and that the statement noted explicitly that the size of the balance sheet could be increased to promote a stronger recovery suggests that the odds of QE3 are increasing. If the recent growth is not sustained, we think that the FOMC could decide to implement it sometime in the spring. A potential QE3 would likely include Treasuries and agency MBS.