Fed: Economy Strong Enough to Handle Interest Rate Hike

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Kevin Wolf/AP
By Howard Schneider and Jonathan Spicer

WASHINGTON -- The U.S. economy is growing moderately after a winter swoon and likely strong enough to support an interest rate increase by the end of the year, but concerns remain over the recovery of the labor market, U.S. Federal Reserve officials said Wednesday.

With the economy still on track to grow as much as 2 percent for the year, the central bank's latest policy statement keeps it on track for at least one and perhaps a second rate increase later this year.

Fed Chair Janet Yellen, however, emphasized that the rate decision was still up in the air and rested squarely on further improvement in the labor market -- renewing her focus on a longstanding concern.

In a press conference following the end of the Fed's two-day policy meeting, Yellen said she wanted "more decisive evidence" that labor markets were healing, and that wages would increase beyond their current "subdued pace."

Even as the Fed appeared to be approaching a decision to proceed with a rate hike as soon as September, "some cyclical weakness in the labor market remains," Yellen said, pointing to the low labor force participation rate and the high level of part-time employment.

Her comments are likely to focus even more attention on upcoming U.S. employment and wage reports, as markets look for signs that continued economic growth is translating into more jobs and higher wages.

After a weak start to the year, highlighted by a first-quarter economic contraction, policymakers said gross domestic product is poised to grow between 1.8 and 2 percent in 2015, down from a March forecast of between 2.3 and 2.7 percent.

The Fed also said the unemployment rate is expected to be slightly higher at the end of the year -- at 5.2 to 5.3 percent -- than previously forecast despite the continued improvement in labor markets. The unemployment rate last month was 5.5 percent.

Inflation remains low but is expected to gradually rise to its 2 percent target over the medium term, the Fed said.

Still, the policy statement and forecasts keep the Fed on track to raise rates once or twice over its four remaining policy-setting meetings this year, an outlook reaffirmed by Yellen's comments in the press conference.

"The Fed has two criteria: labor market improvement, which we continue to see, and confidence that inflation will move to its objectives. That's starting to happen," said Wayne Kaufman, chief market analyst at Phoenix Financial Services in New York.

Financial markets were little moved by the Fed's policy statement. U.S. stock indexes added to losses before rallying to close slightly higher, while prices for U.S. Treasuries inched up. The dollar was weaker against a basket of currencies.

Hedging Bets on Data

Fed policymakers maintained the current near-zero interest rate for now and said a hike would be appropriate only after further improvement in the labor market and greater confidence that inflation would rise.

"Economic activity has been expanding moderately," the Fed said in its policy statement. "The pace of job gains picked up while the unemployment rate remained steady. On balance, a range of labor market indicators suggests that underutilization of labor resources diminished somewhat."

In their projections, Fed officials lowered expectations for economic growth in 2015 after accounting for the weak start to the year. It was the second time since December that the central bank has downgraded its GDP growth forecast for this year.

But 15 of 17 Fed policymakers still indicated the first rate hike should take place this year, no change from their previous set of predictions.

More significantly, policymakers' individual projections for the appropriate federal funds rate at year's end remained clustered around 0.625 percent. However, seven policymakers are now in favor of hiking rates only once or not all this year. In addition, Fed officials see slightly lower rates at the end of 2016 and 2017 than forecast in March.

With rates currently set at a range of between zero percent and 0.25 percent, that would imply two quarter-point rate hikes between now and the end of the year, with many analysts predicting an initial hike in September.

The Fed's meeting this week was the first since the depths of the 2007-2009 financial crisis in which the outcome was not constrained by "forward guidance," the central bank's open-ended commitment to keep rates low to counter the worst downturn since the Great Depression.

9 Numbers That'll Tell You How the Economy's Really Doing
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Fed: Economy Strong Enough to Handle Interest Rate Hike
The gross domestic product measures the level of economic activity within a country. To figure the number, the Bureau of Economic Analysis combines the total consumption of goods and services by private individuals and businesses; the total investment in capital for producing goods and services; the total amount spent and consumed by federal, state, and local government entities; and total net exports. It's important, because it serves as the primary gauge of whether the economy is growing or not. Most economists define a recession as two or more consecutive quarters of shrinking GDP.
The CPI measures current price levels for the goods and services that Americans buy. The Bureau of Labor Statistics collects price data on a basket of different items, ranging from necessities like food, clothing and housing to more discretionary expenses like eating out and entertainment. The resulting figure is then compared to those of previous months to determine the inflation rate, which is used in a variety of ways, including cost-of-living increases for Social Security and other government benefits.
The unemployment rate measures the percentage of workers within the total labor force who don't have a job, but who have looked for work in the past four weeks, and who are available to work. Those temporarily laid off from their jobs are also included as unemployed. Yet as critical as the figure is as a measure of how many people are out of work and therefore suffering financial hardship from a lack of a paycheck, one key item to note about the unemployment rate is that the number does not reflect workers who have stopped looking for work entirely. It's therefore important to look beyond the headline numbers to see whether the overall workforce is growing or shrinking.
The trade deficit measures the difference between the value of a nation's imported and exported goods. When exports exceed imports, a country runs a trade surplus. But in the U.S., imports have exceeded exports consistently for decades. The figure is important as a measure of U.S. competitiveness in the global market, as well as the nation's dependence on foreign countries.
Each month, the Bureau of Economic Analysis measures changes in the total amount of income that the U.S. population earns, as well as the total amount they spend on goods and services. But there's a reason we've combined them on one slide: In addition to being useful statistics separately for gauging Americans' earning power and spending activity, looking at those numbers in combination gives you a sense of how much people are saving for their future.
Consumers play a vital role in powering the overall economy, and so measures of how confident they are about the economy's prospects are important in predicting its future health. The Conference Board does a survey asking consumers to give their assessment of both current and future economic conditions, with questions about business and employment conditions as well as expected future family income.
The health of the housing market is closely tied to the overall direction of the broader economy. The S&P/Case-Shiller Home Price Index, named for economists Karl Case and Robert Shiller, provides a way to measure home prices, allowing comparisons not just across time but also among different markets in cities and regions of the nation. The number is important not just to home builders and home buyers, but to the millions of people with jobs related to housing and construction.
Most economic data provides a backward-looking view of what has already happened to the economy. But the Conference Board's Leading Economic Index attempts to gauge the future. To do so, the index looks at data on employment, manufacturing, home construction, consumer sentiment, and the stock and bond markets to put together a complete picture of expected economic conditions ahead.
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