San Francisco/New York: Federal Reserve policymakers will likely leave intact their delicately worded easy-money message when they meet next week, despite a surprisingly sharp drop in US unemployment that threatens to make a central part of that message irrelevant.
Top Fed officials believe their landmark decision last month to reduce the pace of the US central bank`s bond-buying stimulus was well received by financial markets. That, in turn, allows them to make another USD 10 billion cut to the bank`s monthly bond purchases at the January 28-29 meeting without needing to adjust their promise to keep interest rates low in the future.
As the promise stands, the Fed has said it expects to keep rates near zero until well past the time unemployment falls below 6.5 percent, especially if inflation remains low. Joblessness dropped faster than expected last year and hit 6.7 percent in December, down from 7.0 percent the previous month.
Had the drop in unemployment sparked a selloff in bonds, the Fed might have reinforced its commitment to stimulus by tampering with its low-rates promise. But investors appear to have interpreted the data as a one-off event that would not prompt a quicker-than-expected policy tightening.
So policymakers at next week`s meeting - Fed Chairman Ben Bernanke`s last before handing the reins to Vice Chair Janet Yellen - will probably stick to the same message, saving any big changes for the future.
"No, I don`t think we should revise" the low-rates promise, Philadelphia Fed President Charles Plosser told reporters last week. "I think we need to just stick with what we`ve got."
With the US economy strengthening, the Fed wants to shelve its bond-buying program by later this year. At the same time, wary of false economic starts, it plans to lean more heavily on its low-rate promise to convince investors it will not tighten policy any time soon, probably not until well into in 2015.
Another cut to the purchase of Treasuries and mortgage-backed securities, from USD 75 billion per month now to USD 65 billion, is all but certain next week, based on policymakers` recent comments.
That`s not to say the move would be without controversy. Minneapolis Fed President Narayana Kocherlakota may cast a dissenting vote, based on his recent call for more, not less, monetary stimulus.
But even the president of the Chicago Fed, Charles Evans, among the most dovish of the Fed`s 17 policymakers, is on board with measured reductions to the bond purchases. He has said that, if anything, investors should brace for bigger cuts later this year.
"I would suspect that the hawks have already won the battle" on tapering, said Wells Fargo`s chief economist, John Silvia.
The US central bank has tried to telegraph its intentions from the moment it first cut the key federal funds rate to near zero, saying in December 2008 that it expected to keep it there "for some time."
After a handful of revisions to this so-called forward guidance, it decided in December 2012 to tie its ultra loose policy to an unemployment threshold of 6.5 percent. In yet another change, it said last month that rates would likely remain near zero "well past" that threshold, "especially" if inflation remains below the Fed`s 2 percent target.
Once unemployment reaches 6.5 percent, the threshold "is not going to mean anything any more" in terms of signaling policy, the Chicago Fed`s Evans, the architect of the low-rate pledge, told reporters last week.
He and other policymakers have said they may need to clarify what other measures of the labor market - such as the worrying drop in the workforce participation rate or the encouraging uptick in quit rates - they are tracking.
One simple way the Fed could help shape rate expectations is to release Fed officials` rate forecasts more frequently. The central bank began publishing policymakers` quarterly rate projections in January 2011.
Right now market views appear to be in sync with the Fed`s own expectations, with traders in short-term rate futures betting on a first rate hike no earlier than April 2015. Twelve of the 17 Fed policymakers, meanwhile, expect rates to be at or below 1 percent by the end of 2015.
The Fed also expects unemployment to drop to between 6.1 and 5.8 percent by the end of next year, with inflation rising to 1.5 to 2.0 percent - very likely a comfortable environment to raise rates from rock bottom levels.
But John Williams, president of the San Francisco, told reporters earlier this month that down the road, using policymaker projections "more effectively" may be a better approach to communicating strategy than trying to tweak the Fed`s post-meeting policy statement to perfection.