Fed Prepares To Raise Rates, End Failed QE Policy

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Monetary Policy: The Federal Reserve said Wednesday the economy isn't as strong as it believed just two months ago, and that it's not likely to raise interest rates soon. It's as close to an admission of failure as you'll ever get.

Fed Chairwoman Janet Yellen was admirably blunt in assessing the economy's weakness: "There are still too many people who want jobs but cannot find them, too many who are working part time but would prefer full-time work, and too many who are not searching for a job but would be if the labor market were stronger," she said.

Yep. That pretty much sums it up.

As the Fed hinted in its biannual policy forecast, the famously dynamic U.S. economy is looking rather undynamic these days. The Fed lowered its forecasts for economic growth next year considerably, from a range of 3% to 3.2% just two months ago to 2.6% to 3% now.

When officials have to scramble to lower their forecasts to catch up with reality, it's rarely a good thing. That's certainly the case here.

And yet, while most of the Fed board's members continue to forecast an end to the Fed's 0% interest rate policy sometime next year, this latest forecast raises some doubts about that.

The Fed's Open Market Committee said in a statement that "it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase ends."

Sound like the Fed's going to hold on to the zero-rate policy as long as it can out of fear increases will sink the economy? It sure did to us.

But in fact, a closer look shows the Fed is even now moving to raise rates using two obscure rate tools.

While keeping the benchmark Fed funds rate at near 0%, the Fed now pays interest to banks on reserves they hold at the Fed, a new policy tool for the central bank to raise and lower market rates. Moreover, by using a widely used overnight lending instrument, it can further tighten rates in the market.

So, despite the lower growth expected next year and comments that it will keep zero-rates for a "considerable time," the Fed seems to have quietly embarked on the first steps of a long-term increase in interest rates.

Indeed, its own forecasts show that. In June, Fed officials expected the fed funds rate to be about 1.25% by the end of 2015. Now, they say 1.5% is more likely. In 2016, the Fed in June forecast a 2.5% rate. Now, it's 3%.

In short, while growth is slowing, rates will be rising. Not a typical policy, but perhaps as we said an admission that the previous policy hadn't worked well at all.

The Fed appears to be moving quickly away from its five-year experiment. Next month marks a milestone of sorts - its multiyear experiment with Quantitative Easing, in which it bought $85 billion a month in Federal debt to keep interest rates low, is on track to end.

After tapering the monthly purchases for months, the Fed will purchase just $15 billion in new debt next month - and presumably none the month after. But it won't sell the more than $4 trillion portfolio it has amassed. All of this presents major risks.

"The bottom line is that the Fed has been and will remain behind the curve," wrote First Trust economists Brian Wesbury and Robert Stein in a commentary on Wednesday's Fed actions.

As rates rise, big questions remain: Will the higher rates the Fed is engineering sink the economy? Will we see unemployment return to recession levels?

It doesn't seem likely. And yet, in 2008, if someone had told you that the Census Bureau would report in September 2014 that median income had shrunk 8.2% over the preceding five years, and only those with the highest incomes would see any gains at all, you might have thought that person was crazy.

Well, it happened. Thanks to President Obama's misbegotten economic policies and "stimulus," and the Fed's own radical experiment in money printing, the U.S. has had its worst recovery ever from a recession.

To its credit, perhaps, the Fed is now quietly trying to undo its failed experiment, by letting markets set interest rates and shutting down the QE program. If so, it's a minor victory for common sense and policy prudence.


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