FED OFFICIALS ON TRACK TO RAISE SHORT-TERM RATES LATER IN THE YEAR / THE WALL STREET JOURNAL

Central Banks

Fed Officials on Track to Raise Short-Term Rates Later in the Year

While Europeans Weigh Bond-Buying Program to Boost Growth, U.S. Officials Are Upbeat on America’s Economic Prospects

By Jon Hilsenrath

Jan. 19, 2015 2:14 p.m. ET


Federal Reserve officials are on track to start raising short-term interest rates later this year, even though long-term rates are going in the other direction amid new investor worries about weak global growth, falling oil prices and slowing consumer price inflation.

After their next policy meeting Jan. 27-28, officials are likely to repeat in their statement that they can “be patient” about rate increases. That means no moves for at least the next two meetings—or not until June at the earliest, they have indicated in recent public statements and interviews. At the same time they aren’t likely to signal an alarm about developments abroad that would indicate a meaningful shift in their plans.

Many Fed officials have signaled they expect to start lifting their benchmark short-term rate from near zero around the middle of the year. Recent developments in the economy and markets have caused some trepidation among Fed officials and, if sustained, could cause them to delay acting.

However several have indicated recently they still expect to move this year and are withholding judgment on delay.

“I think it is important to get started and to start normalizing policy,” St. Louis Fed President James Bullard said in an interview with The Wall Street Journal on Monday. “Even once we start to normalize, interest rates would be extraordinarily low.”

While European officials are near launching a new bond-buying program known as quantitative easing to boost feeble growth and low inflation, Fed officials are generally upbeat about U.S. economic prospects. U.S. inflation is below the Fed’s 2% objective, but the unemployment rate fell—to 5.6% in December, which many Fed officials take as a sign that wage and price pressures could be building in the domestic economy. They have held short-term rates near zero since December 2008 and want to start moving them up before those pressures gather force.

Some investors have been betting the Fed will hold off on rate increases. In fed funds futures markets—where traders stake out positions on the expected Fed target rate—the average expected rate for the month of June has drifted down from 0.20% to 0.16% since the beginning of the year, a sign investors in these markets see a diminished likelihood of a midyear rate increase.

“I would have guessed June up until this past week,” Harvard University economics professor Jeremy Stein, a former Fed governor, said in an interview last week.

One worrying development for Fed officials is a drop in yields on 10-year Treasury notes below 2%. Boston Fed President Eric Rosengren said in an interview last week the decline raised questions about whether investors believe the Fed’s forecast that inflation will rise toward 2% in coming years.

Treasury yields tend to move in line with actual and expected inflation. If investors believed inflation was set to rise, yields on government bonds would be rising, not falling.

But other officials believe the drop in bond yields is being caused primarily by global capital flows–most notably a rush of investors into U.S. assets and out of lower-yielding European investments.

These officials are prepared to look through the drop in bond yields for now until there is more convincing evidence U.S. inflation has taken a sustained turn lower.

The Labor Department reported Friday the U.S. consumer price index rose just 0.8% in December from a year earlier, well below the Fed’s goal. But the weak reading is being driven largely by falling energy prices, something officials believe will pass.

Excluding volatile food and energy items, so-called core prices rose 1.6% on the year. That’s slower than a 1.7% annual gain in November and 1.8% in October. If sustained it could cause Fed officials to change their plans, but so far many officials don’t believe the inflation backdrop has materially shifted.

The worry is that inflation well below the 2% goal goes hand-in-hand with a soft economy.

“The level of inflation is not so low that it can alone justify a policy rate of zero,” Mr. Bullard said in a speech Friday. He wants the Fed to start raising rates by March, earlier than most other officials.

San Francisco Fed President John Williams said in a speech Friday the middle of the year may still be the best time for the U.S. central bank to increase rates.

Given the health of the broader economy, “what I’m really watching for is underlying inflation—wage growth, prices,” he told reporters later. “My forecast is once we get through this slow path in inflation it will start moving back,” he said, adding, “I’m not expecting inflation to be 2% when we raise interest rates. I don’t need to be at the goal when we raise the rates.”

While Fed officials appear likely to stay the course at their coming meeting, they are heading toward important and potentially difficult decisions at their subsequent meeting in March. If they are to raise rates by June, they would signal it in March by removing from their statement the language about patience. Continued declines in core inflation or bond yields at that point could convince them to delay such a shift. On the other hand further gains in employment and economic growth would encourage them to proceed toward rate increases.

Central to their internal deliberations ahead of the March meeting is a debate about how low the jobless rate can fall before it stirs wage and inflation pressure. Fed officials estimate the “natural rate” of unemployment—meaning the rate below which wage pressures increase—is between 5.2% and 5.5%.

Mr. Rosengren said he was considering revising this estimate down because the jobless rate has fallen to near the 5.2%-5.5% range without triggering any sign of wage pressure. He said he suspected some of his Fed colleagues also were considering moving this estimate down. The lower the estimate goes, the more patient they might be before raising rates.


—Jim Carlton contributed to this article.