Fed's Dudley: QE3, Low Rates Will Stick Around

NEW YORK CITY-Throwing some cold water on market fears that the Federal Reserve could soon taper off its third round of quantitative easing, the central bank's New York president said Thursday that the Fed would maintain the status quo on QE3 if the economic recovery doesn't keep pace with projections. At a press briefing here Thursday morning, William Dudley, president and CEO of the Federal Reserve Bank of New York, also said a near-term increase in interest rates was unlikely.

“Some commentators have interpreted the recent shift in the market-implied path of short-term interest rates as indicating that market participants now expect the first increases in the federal funds rate target to come much earlier than previously thought,” Dudley said in prepared remarks. Such an expectation, he added, would be “quite out of sync” with both recent statements by the Federal Open Market Committee “and the expectations of most FOMC participants.”

At last week's meeting, Dudley said, the FOMC decided that the current low range for the FFR will remain appropriate “for at least as long as the unemployment rate remains above 6.5%, so long as inflation and inflation expectations remain well-behaved.” 

As for a slowdown in the pace of QE3—currently at $85 billion per month—Dudley said that the FOMC's policy in this area “depends on the outlook, rather than the calendar.” Assuming that economic data over the next year are broadly consistent with the FOMC's expectations, he said, the Fed would then reduce the pace of agency MBS and Treasury purchases “in measured steps” through the rest of 2013 and into mid-2014. That would depend on the unemployment rate, now at 7.6%, hovering around 7% and the economy's momentum strengthening a year from now.

That scenario, Dudley said, is only “one possible outcome” of the economy's actual performance over the next four quarters. Economic circumstances could diverge significantly from the FOMC's expectations,” he said. “If labor market conditions and the economy's growth momentum were to be less favorable than in the FOMC's outlook—and this is what has happened in recent years—I would expect that the asset purchases would continue at a higher pace for longer.”

In addition, even if this best-case scenario panned out and the pace of Q3 was eased, “it would still be the case that as long as the FOMC continues its asset purchases it is adding monetary policy accommodation, not tightening monetary policy,” said Dudley. “As the FOMC adds to its stock of securities, this should continue to put downward pressure on longer-term interest rates,” resulting in a “more accommodative” monetary policy. 

Also, the Fed is likely to keep most of these assets on its balance sheet for a long time.  Dudley noted that, “a strong majority” of FOMC participants no longer favor selling agency MBS securities during the monetary policy normalization process. “This implies a bigger balance sheet for longer, which provides additional accommodation today and continuing support for mortgage markets going forward,” he said. 

An increase in short-term interest rates “is very likely to be a long way off,” Dudley said.  Not only will it likely take “considerable time” to reach the 6.5% unemployment rate threshold, “but also the FOMC could wait considerably longer before raising short-term rates.  The fact that inflation is coming in well below the FOMC's 2% objective is relevant here.” He noted that most FOMC participants don't expect short-term rates to begin rising until 2015.

Dudley's counterpart at the Federal Reserve Bank of Atlanta, Dennis Lockhart, said much the same thing Thursday, the Wall Street Journal reported. “The timing of the first move to raise the policy rate will depend on overall economic conditions, but I would estimate 'liftoff,' as it is called, to come sometime in 2015,” Lockhart said in a speech in Marietta, GA.