Yellen's "tightening" promises a slow crawl higher

Thu Dec 17, 2015 7:04pm EST
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By Howard Schneider

WASHINGTON (Reuters) - The policy tightening kicked off by the Fed this week promises to be among the longest and slowest of modern times, a crawl forward that may last as long as former fed chair Paul Volcker's legendary battle against inflation in the 1980s.

Janet Yellen faces a different challenge - inflation is low, yet the Federal Reserve aims to bring borrowing costs to more "normal" levels after seven years near zero. However, the forecasts released by Fed officials on Wednesday imply that she will need as much patience as the cigar-chomping Volcker did three decades ago.

While Volcker and predecessor Arthur Burns steadily ratcheted rates higher over four years to cool the economy, Yellen will be nudging rates upwards while still keeping policy "accommodative" - loose enough to encourage borrowing and spending - until some time in 2019, according to the latest forecasts from Fed officials.

Yellen's confidence in the strength of the recovery, voiced at a Wednesday news conference, still stands in contrast to a treacherous global environment of falling prices and weak growth. One thing the Fed is keen to avoid is the sort of forced policy retreat experienced in recent years by the European Central Bank and others that raised rates only to cut them again later.

"The key question is whether the U.S. economy is finally robust enough not only to sustain its own recovery but also to lift world trade and global growth," HSBC global chief economist Janet Henry wrote in an analysis of the Fed meeting.

It could take years to find that out as the Fed treads a path to higher rates, with markets expecting an even slower pace of rate hikes than the Fed itself foresees. (Graphic:

"On a historical basis they are being anything but aggressive," said Erik Weisman, chief economist with MFS. "It may be one of those moments where market participants need to see inflation flowing through, need to see growth," before believing the Fed will keep moving.

Trading in Eurodollar contracts on Thursday indicated investors expect the Federal Funds rate to still be below 1 percent at the end of 2016, roughly half a percentage point below the median forecast of Fed policymakers.   Continued...

U.S. Federal Reserve Chairman Janet Yellen listens to a reporter's question during a news conference in Washington December 16, 2015.  REUTERS/Jonathan Ernst