Fed chair Yellen faces first leadership test

3:05 AM, Mar 17, 2014   |    comments
Federal Reserve Chair Janet Yellen listens while testifying Feb. 11 before the House Financial Services Committee. Yellen will hold her first press conference on Wednesday after the Fed concludes a two-day meeting. (Photo: Cliff Owen, AP)
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(USATODAY.com) - New Federal Reserve Chair Janet Yellen faces an important test Wednesday as her first news conference coincides with an anticipated change in the central bank's guidance related to short-term interest rates.

Further tapering of the Fed's stimulus is widely expected at a two-day meeting starting Tuesday. Less certain is how a Fed post-meeting statement and Yellen will convey that rates will stay low despite unemployment that's fallen faster than expected. Yellen pushed the Fed to increase public communication in her previous job as vice chair.

The Fed is "in a little bit of a tricky situation," says Conrad DeQuadros of RDQ Economics.

Many economists expect the Fed to remove the threshold it set for considering the first hike in its benchmark short-term interest rate - near zero since 2008. In December 2012, the Fed said the rate would stay that low at least until unemployment, then 7.9%, falls to 6.5%, assuming inflation is tame.

But the jobless rate already has tumbled to 6.7%, in part because many unemployed Americans got discouraged and stopped looking for work. The Fed recently clarified that its benchmark rate would stay near zero "well past" the time unemployment hits 6.5%. That could come soon, and some Fed officials have said publicly the threshold is now meaningless.

Jim O'Sullivan of High Frequency Economics expects the Fed to instead say it will consider a range of labor market indicators as it weighs a rate increase. Those likely include the number of long-term unemployed Americans, which Yellen says is still too high.

The Fed already has said it's factoring in such measures. But ditching the 6.5% threshold could confuse financial markets, which will have to rely on less specific criteria as they push interest rates up or down in anticipation of Fed moves. It's "a little more subjective," DeQuadros says.

For now, Yellen's message is clear: Near-zero interest rates are still needed. Annual inflation is below the Fed's 2% target. Fed policymakers' latest forecasts from December point to the first rate increase in late 2015.

Yet, some gauges that the Fed could examine more closely if the 6.5% threshold is dropped show a tightening labor market. The short-term unemployment rate - which includes only those out of work less than 27 weeks - has fallen near its pre-recession level. That reflects a tighter labor supply, which often pushes up wages.

O'Sullivan says that may explain a recent rise in wage growth after years of stagnation. If higher wages fuel inflation, the Fed might have to consider raising interest rates earlier in 2015.

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