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Fed keeps rates low, but brace for the inevitable

Created: 09/18/2014 9:21 AM
By: PAUL WISEMAN MARTIN CRUTSINGER

WASHINGTON (AP) — Record-low interest rates will be around for at least a few more months, the Federal Reserve made clear Wednesday.

Enjoy the easy money while it lasts.

By mid-2015, economists expect the Fed to abandon a nearly 6-year-old policy of keeping short-term rates at record lows. Those rates have helped support the economy, cheered the stock market and shrunk mortgage rates. A Fed rate increase could potentially reverse those trends.

Mortgages could cost more. So could car loans. Investors could get squeezed.

"Borrowers should see the writing on the wall," said Greg McBride, chief financial analyst at Bankrate.com. "Interest rates are eventually going to go up. They should pay down variable-rate debt and keep an eye on that adjustable-rate mortgage. They don't want to be caught flat-footed."

Investors, in particular, might recall that mere speculation about the end of the Fed's stimulus shook global financial markets in May 2013. In coming months, as the prospect of higher rates nears, traders might once again dump stocks and bonds and send prices tumbling.

Higher yields on bank accounts and CDs could provide some modest relief for savers and retirees who have struggled for years to get by on meager interest income. But any gains they receive could be diminished by the likelihood that inflation will be higher once the economy is strong enough for the Fed to end its ultra-low rate policy.

Still, on Wednesday, Fed policymakers once again decided: Not yet.

The central bank said it intends to keep its benchmark rate near zero as long as inflation remains under control, until it sees consistent gains in wage growth, long-term unemployment and other gauges of the job market.

The Fed retained language signaling its plans to keep short-term rates low "for a considerable time" after it ends its monthly bond purchases after its next meeting in October.

The decision sent the Dow Jones industrial to a record high Wednesday. And on Thursday, stocks extended their gains. The Dow rose 86 points in midmorning trading.

"What we heard from the Fed today is really what investors like to hear," McBride said. "The stimulus isn't going to go away overnight."

In its statement, the Fed said it will make another $10 billion cut in the pace of its Treasury and mortgage bond purchases, which have been intended to keep long-term borrowing rates low.

"In the Fed's mind, the economy still has work to do, but it's improving," said Mike Arone, an investment strategist with State Street Global Advisors.

The Fed also clarified the process by which it will eventually unwind its low-rate policies. The Fed said it would first raise its key short-term rate before it stops reinvesting its bond holdings, which have driven the Fed's balance sheet to a record of nearly $4.5 trillion.

The central bank also issued updated forecasts for growth, inflation and interest rates. The median short-term rate supported by Fed policymakers at the end of 2015 is now 1.38 percent, up from 1.13 percent at its June meeting. This suggested pressure from some Fed officials for a faster rate increase than the Fed's statement implied.

The Fed also expects slower growth this year and next than in its last projections issued in June. It predicts that the economy will grow about 2.1 percent this year, down from its June forecast of roughly 2.2 percent. That reduction likely reflects the sharp contraction in the first quarter of this year. The economy has rebounded solidly since then.

On the eve of the Fed's meeting this week, the financial world had been on high alert for whether the Fed would reiterate that it expects to keep its key short-term rate near zero for a "considerable time" after the bond buying ends.

With job growth solid, manufacturing and construction growing and unemployment at a near-normal 6.1 percent, many analysts had suggested that the Fed was edging closer to a rate increase to prevent a rising economy from igniting inflation.

The number of U.S. job openings is near its highest level in 13 years. Layoffs have dwindled. And consumer confidence has reached its highest point in nearly seven years.

Despite the signs of a stronger economy, most economists think the first increase in the Fed's short-term rate won't occur until mid-2015.

The Fed's new statement retained language stating that a range of labor market indicators "suggests there remains significant underutilization of labor resources."

Meeting with reporters after the Fed meeting, Chair Janet Yellen said she still thought the job market has yet to fully recover.

"There are still too many people who want jobs but cannot find them, too many who are working part time but would prefer full-time work and too many who are not searching for a job but would be if the labor market were stronger," Yellen said.

The Fed made only minor changes to its previous statement in its assessment of the economy. The statement was approved on an 8-2 vote.

The dissents came from Charles Plosser, president of the Fed's Philadelphia regional bank, who had dissented at the last meeting, and Richard Fisher, president of the Dallas regional Fed bank. Both are viewed as "hawks" — Fed officials who are most concerned about the threat of inflation and believe the Fed should be moving more quickly to raise rates.

Asked at her news conference whether she had concerns about the dissents, Yellen noted that the committee had approved the policy statement by "an overwhelming majority, and I don't consider the level of dissent to be surprising or very abnormal."

In response to another question, Yellen said it could take until the end of the decade to shrink the Fed's investment holdings to more normal levels.

Before its policy announcement Wednesday afternoon, the Fed had received good news on inflation with a report that consumer prices fell by a seasonally adjusted 0.2 percent in August, the first monthly drop in prices in 16 months.

In August, U.S. employers added just 142,000 jobs, well below the 212,000 average of the previous 12 months. The slowdown was seen as likely temporary.

But some analysts said it underscored that the economic outlook might remain too hazy for the Fed to signal an earlier-than-expected rate hike.

___

AP Economics Writers Christopher S. Rugaber and Josh Boak contributed to this report.

(Copyright 2014 by The Associated Press. All Rights Reserved.)

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