Low Inflation Dogs Fed Even as Job Gains Point to Rate Increase

By Christopher Condon and Craig Torres

Photographer: David Paul Morris/Bloomberg

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Even as they move closer to raising interest rates above zero this year, Federal Reserve officials are wrestling with concerns that inflation may stay below their goal -- a worry compounded by the steep drop in oil prices.
“There is more concern over the inflation situation, and that’s going to frame the debate for the coming weeks,” said Thomas Costerg, an economist at Standard Chartered Bank in New York.
Minutes of the Federal Open Market Committee’s Dec. 16-17 meeting, released Wednesday in Washington, showed the committee agreed the U.S. economy was likely to continue improving, leading to more job gains. The minutes also repeated Chair Janet Yellen’s predictions that inflation would move up toward the Fed’s target as the labor market strengthens.
Yet a closer reading revealed that worries over too-low inflation were
more widespread than suggested by the FOMC’s Dec. 17 statement, which recorded a dissent by Minneapolis President Narayana Kocherlakota over just that issue.
“With regard to inflation, a number of participants saw a risk that it could run persistently below their 2 percent objective, with some expressing concern that such an outcome could undermine the credibility of the Committee’s commitment to that objective,” the record showed.
“A number” on the panel also voiced concern that risks to their inflation forecasts “tilted to the downside,” citing the danger that low inflation could prove more persistent than expected.

‘Considerable Time’

With the U.S. economy strengthening and unemployment at a six-year low, the FOMC in December dropped a pledge to keep interest rates low for a “considerable time.” The panel instead said it will be “patient” in considering the timing of the first rate increase since 2006.
The minutes confirmed Yellen’s statement at her press conference last month that the Fed’s new policy guidance means it’s unlikely to increase borrowing cost before the late April meeting.
Fed officials also said the faltering global economy may be a threat to the U.S., while concluding that those risks were “nearly balanced” by positive developments. Some officials were confident that other major central banks would act to stimulate their economies.

Further Responses

“While some participants had lowered their assessments of the prospects for global economic growth, several noted that the likelihood of further responses by policymakers abroad had increased,” according to the minutes.
Stocks maintained gains as the minutes did little to alter expectations on the timing of tightening. The Standard & Poor’s 500 Index rose 1.2 percent to 2,025.90 at the 4 p.m. close of trading in New York. The benchmark 10-year Treasury yield rose three basis points, or 0.03 percentage point, to 1.97 percent.
While unemployment is falling, the Fed continues to miss on the second part of its mandate, stable prices.
The Fed’s preferred gauge, the personal consumption expenditures price index, has remained below the target for 31 consecutive months and has been edging lower since May with the plunge in oil. The index showed prices rose 1.2 percent in the year through November.

Trending Downward

“You need to see more of an upward slip in core inflation and we’re not seeing that, and it may continue to trend downward,” Costerg said.
Yellen has made it clear she would look past the impact of oil to core inflation, which strips out volatile food and energy costs. Core prices rose 1.4 percent in November.
Fed officials, including Yellen, have also acknowledged that lower oil prices will eventually have an impact on core inflation. A strong dollar, which holds down prices of imported goods, may also restrain inflation.
Policy makers are also struggling to explain a decline in expectations for future inflation. A measure of inflation expectations five years ahead starting five years from now, derived from yield differences on government bonds, was 1.9 percent this week, the lowest reading in 14 years.

Expectations Discussed

The minutes showed the committee discussed inflation expectations at length, without any firm conclusions except that the issue required “more time and analysis.” Officials have pointed out that gauges of expectations based on consumer surveys have remained stable.
Most Fed officials expect to raise the benchmark federal funds rate sometime in 2015, according to quarterly forecasts released last month. They forecast inflation of 1 percent to 1.6 percent this year, lower than their projections in September.
“The Fed’s current forecast has the committee starting to raise interest rates at a time when inflation is still very below target,” said Guy Lebas, a Philadelphia-based chief fixed income strategist for Janney Montgomery Scott LLC, a brokerage firm. “It seems that the Fed has a hope that it will raise rates, but they are looking for a way to justify that hope.”
For Standard Chartered’s Costerg, the “make-or-break” level for core inflation is 1.5 percent, about where it is now. “Below that I think it will be difficult” to raise rates, he said.