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Yellen Rate Raises Seen as Gradual in Survey as Inflation Muted

Photographer: Andrew Harrer/Bloomberg

U.S. Federal Reserve Chair Janet Yellen.

Even after five years of steady economic growth, Federal Reserve Chair Janet Yellen is likely to raise interest rates only gradually between 2015 and 2017 as inflation remains muted, according to a Bloomberg survey of economists.

Fifty-six percent of 61 economists said the median of policy makers’ forecasts for the benchmark interest rate at the end of 2017 will be below their median estimate for the longer-run rate. Forty-one percent said the rate would be at the longer-run median. The survey was conducted Sept. 11-15.

Policy makers, who start a two-day meeting today, are considering how much progress toward their goals of full employment and stable inflation would be needed to prompt the first rate increase since 2006. They will outline their outlook for the economy in quarterly projections for growth,unemployment (USURTOT), inflation and the benchmark federal funds rate.

“There is certainly a majority” on the Federal Open Market Committee, including Yellen, “who still see slack in the labor force and no evidence of inflation, and would like to err on the side of lower interest rates for longer,” said Scott Clemons, chief investment strategist for the private banking unit at Brown Brothers Harriman & Co. in New York.

Broader Measures

Unemployment fell to 6.1 percent in August from 7.2 percent a year earlier, in part because people have dropped out of the labor force. Yellen has focused on broader measures of job-market health, such as the share of the jobless who have been out of work for 27 weeks or longer, which stands at 31 percent, compared with an average of 19 percent from 2004 to 2007.

The FOMC said in July that “a range of labor-market indicators suggests that there remains significant underutilization of labor resources.”

The Bloomberg survey also showed that 57 percent of economists expect the median estimate for the federal funds rate at the end of 2015 to remain near the June forecast of 1.13 percent. Thirty-four percent said it would be higher than the June forecast.

Economists predict inflation will remain tame. Fifty-three percent said the personal consumption expenditures price index, the Fed’s preferred price gauge, won’t show a third consecutive month of readings of 2 percent or higher until the final quarter of 2015 or later. The index has been below the Fed’s 2 percent target for more than two years.

Hotter Economy

The FOMC would rather keep rates low to “let the economy heat up a little bit,” said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago.

Still, some traders in Eurodollar options are betting that the tightening will be quicker than most other investors anticipate.

Since the FOMC’s last meeting in late July, the number of open put options contracts that expire this year and grant the right to sell Eurodollar futures that expire in December 2017 has risen to the highest level of the year relative to that for call options, which allow for purchases of the money-market derivative.

Fed officials showed in June that they are willing to take a slow approach to raising rates. They estimated that unemployment would average 5.1 percent to 5.5 percent at the end of 2016, with inflation slightly below their 2 percent goal. Even then, their median estimate for federal funds rate at the end of 2016 was 2.5 percent, more than a percentage point below their forecast for the longer run, which was 3.75 percent.

Go Slow

“There is something to be said for taking it slow,” said Paul Ashworth, chief U.S. economist at Capital Economics NA Ltd in Toronto. “You have to have interest rates lower to try and get people to spend rather than save.”

Fed officials are also debating a change to their pledge to keep rates low for a “considerable time” after they conclude a program of bond purchases intended to boost economic growth by keeping long-term rates low. The purchases are slated to end after the October meeting.

Economists in the Bloomberg survey were almost evenly divided over whether the Fed will retain the “considerable time” language this month, with 53 percent saying the phrase would stay in the statement.

Dropping the language is likely to push up Treasury yields, economists said, with 60 percent predicting such a decision would push up the 10-year note yield 25 to 50 basis points by the end of the year. Almost a fifth said yields would show little change, while 16 percent said yields would rise 50 to 75 basis points. A basis point is 0.01 percentage point.

Yields on 10-year Treasuries stood at 2.59 percent late yesterday, up from 2.34 percent at the end of August.

Seventy-five percent of economists in the survey said Yellen will emphasize the need to be flexible and responsive to economic data in her press conference after the meeting, while 33 percent said she would emphasize slack remaining in labor markets.

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