April 23, 2014 6:17 pm

Federal Reserve on course for further $10bn taper

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The US Federal Reserve is highly likely to slow its asset purchases by another $10bn next week as the economy shakes off its winter torpor.

Retail sales, industrial production and payrolls growth were all robust in recent weeks, adding to evidence of accelerating growth, after a cold winter led to fears for the economic outlook.

The US economy’s resilience means debate among officials on the rate-setting Federal Open Market Committee is moving away from the short-term outlook and towards long-run questions about how the economy will behave as it nears full employment.

“In recent months, some indicators have been notably weak,” said Janet Yellen, the Fed chairwoman, in a speech last week, “but my FOMC colleagues and I generally believe that a significant part of the recent softness was weather related.”

The Fed will not update its forecasts or hold a press conference at this meeting, which concludes on April 30, so aside from modest changes to its statement the only action is likely to be a further taper in purchases to $45bn a month.

Leaving aside the weather, the economy has largely conformed to the Fed’s expectations so far this year – a rarity since the recession. It has meant a period of unusual stability in the Fed’s expected policy path.

“The FOMC’s current outlook for continued, moderate growth is little changed from last fall,” said Ms Yellen, with the economy nearing full employment and 2 per cent inflation at the end of 2016. “I find this baseline outlook quite plausible.”

The one area where the economy is undershooting forecasts is on inflation. The Fed’s preferred measure continues to hover around 1 per cent.

“I don’t have a good explanation of why inflation has been running as low as it is,” said James Bullard, president of the St Louis Fed, in a recent interview with the Financial Times. “I do think that inflation has stabilised at a relatively low level.”

Mr Bullard, like a number of other Fed officials, expects inflation to pick up later this year. By itself, continued weakness in inflation is unlikely to prompt any change in the Fed’s $10bn-a-meeting path for tapering asset purchases, but it would encourage the central bank to let unemployment fall further before raising rates.

With little to respond to on the short-term outlook, the FOMC is likely to debate the amount of spare capacity in the economy, which depends on whether groups such as the long-term unemployed, dropouts from the labour market, and part-time workers can get full-time jobs.

The committee may also start to look in more detail at how it will operate when the time comes to raise rates – a big debate is brewing about how it will manage the federal funds rate now that banks have trillions of dollars in reserves.

Another looming issue is a shortage of Fed board members. If the Senate does not confirm Stanley Fischer and Lael Brainard by May 28, when Jeremy Stein leaves, there will only be three board members left.

That is an operational nightmare since no two of the three could talk to each other without forming a quorum of the board – which is illegal without giving advance notice.

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