Fed Officials Saw Recovery Curbed by Unemployment

April 6 (Bloomberg) -- Federal Reserve officials saw signs of a strengthening recovery that could be hobbled by high unemployment and tight credit, and some warned of raising rates too soon, according to minutes of their March meeting.

“While recent data pointed to a noticeable pickup in the pace of consumer spending during the first quarter, participants agreed that household spending going forward was likely to remain constrained by weak labor market conditions, lower housing wealth, tight credit, and modest income growth,” minutes of the March 16 Federal Open Market Committee released today in Washington showed.

Fed officials are looking for signs of self-sustaining growth before they begin their exit from the most aggressive monetary policy in history. Payrolls rose by 162,000 last month, the most in three years, and manufacturing grew at the fastest pace in more than five years. At the same time, sales of existing homes fell for a third month in February.

The FOMC said in its statement last month that the recovery “is likely to be moderate for a time.” Low rates of resource use and subdued inflation “are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” their statement said. Central bankers have used the “extended period” phrase in statements since March 2009.

Forward Guidance

The minutes showed policy makers discussed the statement language and said “such forward guidance would not limit the Committee’s ability to commence monetary policy tightening promptly if evidence suggested that economic activity was accelerating markedly or underlying inflation was rising notably.”

Stocks and Treasuries rose after the report. The Standard and Poor’s 500 index climbed 0.3 percent to 1,190.65 at 2:23 p.m. in New York. Yields on U.S. two-year notes fell two basis points to 1.14 percent. A basis point is 0.01 percentage point.

An extended period of low rates “might last for quite some time and could even increase if the economic outlook worsened appreciably or if trend inflation appeared to be declining further,” the minutes said. “A few members also noted that at the current juncture the risks of an early start to policy tightening exceeded those associated with a later start.”

The minutes also showed that policy makers were surprised by the rate at which inflation was decelerating.

A price gauge favored by Fed officials, the personal consumption expenditures price index, minus food and energy, rose 1.3 percent for the year ending February, slowing from a 1.5 percent rate in January.

Inflation Readings

“Participants saw recent inflation readings as suggesting a slightly greater deceleration in consumer prices than had been expected,” the minutes said. “A number of participants observed that the moderation in price changes was widespread across many categories of spending.”

Fed officials stated a longer-run goal of 1.7 percent to 2 percent for the full PCE price index in January. Central bankers last month left the benchmark interest rate in a range of zero to 0.25 percent, where it has been since December 2008.

Officials are considering a variety of tools to tighten policy, from raising the rate they pay on reserves banks keep at the Fed to selling assets. Officials discussed allowing maturing Treasury securities to roll off the balance sheet without reinvestment. Such redemptions would lower the interest rate sensitivity of the Fed’s portfolio over time, the minutes said, and limit the need to use other draining tools.

“Nevertheless, the initiation of a redemption strategy might generate upward pressure on market rates, especially if that measure led investors to move up their expected timing of policy firming,” the minutes said. “Participants agreed that the Committee would give further consideration to these matters” while the central bank continues its current practice of reinvesting all maturing Treasury securities.

Purchase Program

U.S. central bankers last month completed their program to purchase $1.25 trillion of mortgage-backed securities, expanding the Fed’s balance sheet to $2.31 trillion on March 31, near the record $2.32 trillion the previous week.

Chairman Ben S. Bernanke told the House Financial Services Committee March 25 that he anticipates “at some point we will in fact have a gradual sales process so that we can begin to move our balance sheet back to its pre-crisis condition” which he described as “under” $1 trillion.

Officials in January unanimously agreed that Fed assets and banks’ excess cash will need to shrink “substantially over time” and return the central bank’s holdings to just Treasuries.

Asset Bubbles

The minutes showed Fed officials are trying to identify potential asset-price bubbles and determine whether financial firms are using too much debt to boost returns.

“Members noted the importance of continued close monitoring of financial markets and institutions” in order to see “significant financial imbalances at an early stage,” the Fed said. “At the time of the meeting the information collected in this process, including that by supervisory staff, had not revealed emerging misalignments in financial markets or widespread instances of excessive risk-taking.”