By Nick Timiraos
Federal Reserve officials are set to raise short-term interest
rates at their meeting in two weeks but could defer the following
expected rate move in September if Congress roils markets by
delaying action on raising the federal government's debt
ceiling.
The possibility that Congress and the White House might have
trouble reaching agreement in September to raise the federal debt
limit and approve government funding for the year beginning Oct. 1
has surfaced as a new source of uncertainty in recent weeks.
Since raising rates in March, many officials have said they
probably would want to lift rates twice more, likely in June and
September. After that, some officials have said they might pause
rate increases to start the process of slowly shrinking the Fed's
$4.5 trillion portfolio of bonds and other assets at year-end
before resuming rate increases in 2018.
Now, the looming debt-limit fight has some officials pondering
whether they might delay the third rate increase until after
September or initiate the portfolio wind-down sooner, perhaps as
early as September, if a rancorous fiscal fight threatens to
disturb markets.
For now, though, Fed policy is on a smooth track. At their May
meeting, officials forged consensus around a strategy for slowly
and predictably reducing the balance sheet of Treasury securities
and mortgages by allowing a small number of assets to mature every
month without reinvesting any proceeds, according to interviews and
their public statements.
The Fed would start by allowing a small amount of net maturities
per month and allow that amount to rise each quarter. It hasn't yet
outlined those amounts. Officials are unlikely to say how big the
portfolio will be at the end of the process until it is further
along.
The agreement on this approach could be announced as soon as
June 14, after the Fed's two-day policy meeting.
Officials are likely to vote then to raise their benchmark
short-term rate by a quarter percentage point to a range between 1%
and 1.25%. They also will release new economic and rate projections
for the rest of the year, which will likely indicate they still
expect to raise rates again later this year.
The Fed's path ahead is "the most telegraphed monetary policy of
our lifetimes," San Francisco Fed President John Williams said
Monday at a conference in Singapore.
Fed Chairwoman Janet Yellen is set to take questions from
reporters after the June meeting, which would let her explain the
central bank's intentions in detail.
Officials want the process of shrinking the balance sheet to be
predictable and boring, with lots of advance notice to markets,
"the policy equivalent of watching paint dry," Philadelphia Fed
President Patrick Harker said last week.
They want to avoid a rerun of the 2013 "taper tantrum," when
investor concerns over the Fed's decision to slow the pace of asset
purchases triggered market turmoil, leading to a sharp increase in
Treasury yields and capital outflows from emerging markets.
The Fed stopped adding to the balance sheet more than three
years ago, but has been reinvesting the proceeds of maturing assets
to keep its holdings steady. Those reinvestments have helped to
hold down long-term interest rates, and allowing them to roll off
without reinvestment could push up long-term rates.
Markets have largely shrugged off the details of the plans as
officials have dribbled them out, giving the Fed a green light to
finalize them.
Clarity on the plans for June have given officials time to look
ahead to when to next raise rates and when to implement the
balance-sheet strategy. The looming debt-limit fight is one
potential complication.
Standoffs between Republicans and the Obama administration
repeatedly pushed the envelope on debt-ceiling brinkmanship,
unsettling markets. This is the first time the Trump administration
navigates the issue with sometimes unruly GOP congressional
majorities.
The deadlines have been well known for months, but it isn't
clear how Congress and the administration will resolve the issue.
One sign of the new administration's unpredictability came earlier
this month after President Donald Trump agreed to a short-term
funding bill. Mr. Trump said on Twitter the U.S. might benefit from
a "good shutdown" this fall to force a confrontation over
government spending.
The Treasury Department began employing emergency
cash-conservation steps in March to avoid breaching the federal
borrowing limit, set at $19.9 trillion, after a 16-month suspension
of the debt ceiling expired.
Analysts initially said those steps might last into the fall,
but Treasury Secretary Steven Mnuchin last week asked Congress to
raise the borrowing limit before lawmakers head home for their
August recess. White House Budget Director Mick Mulvaney told
lawmakers that was necessary because federal receipts have been
coming in "a little bit slower than expected," whittling down the
Treasury's cash balance.
Congress also must reach agreement to extend government funding
that expires Sept. 30, creating the potential for additional
wrangling.
In 2011, Standard & Poor's downgraded the U.S. triple-A
credit rating for the first time after the Treasury came within
days of being unable to pay some bills. In 2013, the U.S.
government endured a 16-day-long shutdown that ended with a bill to
extend the debt limit. Congress agreed to the most recent extension
in October 2015 after then-House Speaker John Boehner cut a deal
with the White House shortly before resigning from Congress.
Fed officials have changed plans before when political
uncertainty threatened to stir financial turbulence. They had
tentatively planned to raise rates last June, but held off out of
concern the U.K. vote on leaving the European Union might cause
market upheaval. They waited until after the U.S. presidential
election before raising rates at the end of 2016.
Another issue for Fed officials to consider is the recent
slowdown in inflation. They indicated at their May 2-3 meeting they
were prepared to look past a surprise ebbing in March, and overall
prices partially rebounded in April. But prices excluding food and
energy in the Fed's preferred inflation gauge were up just 1.5% on
the year in April, the weakest reading since the end of 2015,
according to Commerce Department data released Tuesday.
If the recent slowdown persists, officials may need to "reassess
the expected path" of short-term rates, said Fed governor Lael
Brainard in a speech in New York on Tuesday. She added, "It is
premature to make that call today."
The yield on the benchmark 10-year Treasury note settled at
2.217% on Tuesday, near the lowest level of the year, on investors'
expectations softer inflation might prompt the Fed to move more
slowly in raising interest rates.
Several officials currently place more emphasis on the strong
labor market. Steady job gains have pushed a range of employment
measures to their sturdiest levels in nearly a decade, including an
unemployment rate at 4.4% in April. The May employment report is
scheduled for release Friday.
Officials say they remain confident such low unemployment will
be enough to lift inflation toward their 2% target in coming years,
meeting the Fed's twin objectives of stable prices and maximum,
sustainable employment.
"The U.S. economy is about as close to the Fed's dual mandate
goals as we've ever been," Mr. Williams said Monday. In reaching
those targets, "it is better to close in on the target carefully
and avoid substantial overshooting," he said.
Write to Nick Timiraos at nick.timiraos@wsj.com
(END) Dow Jones Newswires
May 30, 2017 19:18 ET (23:18 GMT)
Copyright (c) 2017 Dow Jones & Company, Inc.