Federal Reserve Expects to Keep Interest Rates Low Through Mid-2015

Sept. 13, 2012— -- The Federal Reserve announced its highly-anticipated quantitative easing, or its so-called QE3, purchasing additional agency mortgage-backed securities at a pace of $40 billion per month in another effort to stimulate the struggling economy.

The Fed wants to lower near-zero interest rates, citing an "elevated" unemployment rate and "strains in global financial markets."

The Fed said it was "concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions."

Scott Brown, chief economist with Raymond James, said the Fed's open-ended securities purchases will depend critically on the jobs market. On Friday, the Labor Department announced the U.S. added a meager 96,000 jobs in August though the unemployment rate fell to 8.1 percent on account of the unemployed leaving the labor force.

The Federal Reserve said it expects the unemployment rate to remain around 8 to 8.2 percent through 2012, 7.6 to 7.9 percent in 2013, 6.7 to 7.3 percent in 2014 and 6 to 6.8 percent in 2015.

"The idea is that you want to encourage more economic activity," Brown said. "Having low interest rates, consumers are more likely to be able to borrow, take risks and to make car and home purchases."

The Fed's policies will help keep mortgage rates down, though monetary policy affects the economy with a lag.

"People shouldn't expect this to light a fire under the economy right away," he said.

The Federal Reserve released its post-meeting policy statement at 12:30 P.M. eastern time after the Federal Open Market Committee (FOMC) completed its two-day meeting.

The committee also said it will extend the average maturity of its holdings of securities it announced in June through the end of the year.

In its statement, the Federal Reserve said it would keep the federal funds rate at zero to 1/4 percent at least through mid-2015.

The U.S. financial markets spiked after the statement was released. The Dow Jones Industrial average rose 0.81 percent to 13,441 while the S&P 500 was up 0.78 percent to 1,447 minutes after the announcement.

This is the fourth of five economic projections the committee makes a year. The next two-day meeting and projections will take place Dec. 11 and 12.

In previous announcements, the Federal Reserve had said it expected to keep short-term interest rates near zero until 2014.

Brown said Thursday's announcement could be perceived as countering further economic and political headwinds next year.

The so-called fiscal cliff is expected in 2013, which includes the expiration of Bush-era tax cuts and the two percentage point reduction in the payroll tax, plus the start of automatic spending cuts.

"We may see most of that kicked down the road if they extend a portion of Bush tax cuts," Brown said. "But we don't know that. There's a lot of uncertainty which is also a negative."

Ahead of the Federal Reserve's announcement, government-sponsored Freddie Mac announced fixed mortgage rates held steady as the financial markets speculated there would be further stimulus.

The 30-year fixed-rate mortgage averaged 3.55 percent for the week ending Sept. 13, the same as the previous week. Last year at the same time, the 30-year rate averaged 4.09 percent.

The 15-year rate averaged 2.85 percent this week, down from 2.86 percent last week and 3.3 percent a year ago.

"If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability," the central bank said in its statement.

Francisco Torralba, economist in Morningstar's Investment Management division, said he was "skeptical" that the Fed's actions will have a strong effect on the economy.

He said three issues will have a stronger impact on hiring and business spending: the fiscal cliff, the banking crisis in Europe, and the global economy at large, including how China will address its slowdown.

He called the Fed's communication strategy regarding near-zero interest rates a "double-edged sword."

He said a policy of "unconditional, semi-permanent zero interest rates can be self-defeating" if it negatively shapes the economic expectations of the public.

"Is the Fed announcing zero short-term rates 'forever' because they want to stimulate the economy, or because they expect a weak economy until 2014?" he asked. "If the Fed was expecting policy to improve things within the next couple of years, why would they commit to low rates? Does that mean that they don't expect low interest rates to work?"

The economic "hawks" within the FOMC have feared that large purchases of Treasuries and a commitment to low rates, would lead to higher inflation in the future, or to an unmooring of inflation expectations, he said.

"I do not agree with this position, but their opinion has not changed," he said.

As Torralba expected, the Federal reserve did not announce a new program of Treasury purchases, and instead expanded its mortgage-backed securities purchase program.

"Employment and growth have deteriorated, but not to alarming levels, and inflation is not dangerously low—at least not yet," Torralba said. "Besides, in spite of Bernanke's defense of Treasury purchases at Jackson Hole, the level of confidence on this particular policy action within the FOMC has decreased."

On Aug. 31, chairman Ben Bernanke gave the keynote speech in Jackson Hole, Wyo. at the Federal Reserve of Kansas City's Economic Symposium, saying its policies "can be effective."

Torralba said the second round of Treasury purchases, first announced in Nov. 2010, expanded the monetary base but "did nothing to increase lending."

As a part of so-called QE2, the Fed reinvested in securities purchased during QE1 and purchased $600 billion in long-term Treasury securities.

Torralba said QE2 lowered long-term interest rates by less than the first round of quantitative easing, which began in late 2008, at the height of the financial crisis.

It was during the first round that the central bank purchased $500 billion in mortgage-backed securities and $100 billion in debt from Fannie Mae, Freddie Mac, and other housing organizations. The first round completed in the first quarter of 2010.

Though QE2 may have boosted asset prices, "this had a negligible effect on real economic spending," he said.

On Aug. 29, the Commerce Department reported the U.S. economy grew at 1.7 percent in the second quarter, a slowdown compared to the 2 percent growth rate in the first quarter.

The Federal Reserve's projection for GDP growth for the remainder of 2012 was 1.7 to 2 percent. For 2013, it projected 2.5 to 3 percent, and 3 to 3.8 percent in 2014 and 2015.

Torralba said he doesn't believe the Fed has a political agenda, though the chances for any incumbent president for re-election may improve if the Fed's actions are successful in improving the economy.

"The economy has been sagging for two years, and in the last four or five months it has slowed down a bit further. The economy is clearly far from the full-employment point, and one of the Fed's mandates is clearly not being fulfilled," he said.