* Fed officials eye economic thresholds as policy guide
* Thresholds would signal when rate-hike decision nearing
* Trick is getting hair-trigger markets to behave
By Jonathan Spicer
NEW YORK, Nov 20 Federal Reserve officials want
to tell the world what would cause them finally to reverse four
years of easy U.S. monetary policy, but something is keeping
them up at night.
In the central bank's nightmare scenario, anxious investors
drive up Treasury yields and abandon stocks as the nation's
unemployment rate edges toward a level officials had flagged as
a goal, effectively tightening financial conditions and
undermining monetary policy before the Fed was ready to act.
The worry is that such a situation could trip up the slow
recovery from the Great Recession just when the U.S. economy
finally gains pace. The Fed is carefully plotting how to avoid
this communications nightmare.
These worries are slowing progress toward an agreement among
the Fed's 19 policymakers on so-called thresholds - economic
data points, like specific unemployment and inflation rates -
that would signal when the central bank is likely to begin
raising benchmark interest rates from near zero.
Many of the officials want to adopt them and influential Fed
Vice Chair Janet Yellen voiced her strong support last week,
making the project sound all but inevitable.
In his most detailed public comments on the growing debate,
Bernanke on Tuesday called the thresholds "a very promising
direction" for policy because it would help markets predict
future Fed decisions. But it would be a challenge to summarize
into "two or three numbers" the conditions necessary for the Fed
to tighten policy, he cautioned.
Such a rule would probably hinge on several pieces of
economic information, such as the number of Americans hunting
for work. If adopted, the rule would be the latest step toward
Bernanke's goal of a more transparent central bank.
But the trick is getting a hair-trigger market to behave.
Although the Fed's aim would be to inform the market how
long its ultra-easy policies will stand, that could backfire if
investors interpret the conditional thresholds as automatic
triggers, or if they try to front-run tighter policies.
"Aggressive traders are all for the Fed going in that
direction because it will put money in their pocket," said Brian
Reynolds, chief market strategist at New York brokerage
"If you give them some concrete rules laid out in advance,
the hedge funds will beat the Fed to the punch," he said.
To be sure, investors have long tried to predict changes to
monetary policy. Indeed, markets need to react for those
policies to work effectively. But as the Fed tests new ways to
explain its unprecedented easing, it might court trouble if
communications rules are too precise.
Fed officials are well aware of this threat, setting the
stage for a delicate few months of trying to persuade investors
that whatever rule they adopt is credible and helpful, but not
set in stone.
They could also abandon the idea altogether.
PROCEED WITH CAUTION
Thresholds would replace a pledge the central bank has made
to keep rates low until mid-2015. Many Fed officials and outside
economists do not like this "calendar date" because it seems
rigid or far-fetched and can be misinterpreted as a promise.
Hinting at the challenges ahead, Yellen, who chairs a Fed
subcommittee on communications and is a front-runner to succeed
Bernanke in 2014, stressed last week that the thresholds would
not trigger a rate hike. She also said that decision would
require further deliberation by policymakers.
But not everyone is convinced the message will get through.
Philadelphia Fed President Charles Plosser, who sits on
Yellen's subcommittee, said thresholds could be misinterpreted
as longer-run policy goals. "I am concerned that we would create
more confusion than clarity," he said on Thursday.
Plosser voiced similar concerns back in January, when the
Fed's latest change in communications confused some investors.
Emerging from a policy-setting meeting, the Fed announced it
intended to keep rates low until late 2014 and then, hours
later, published for the first time charts showing that more
than a third of its policymakers expected a rate rise before
The contradicting messages whiplashed bond markets and may
have instilled some extra caution in the central bank as it
looks forward to yet new ways to refine communications.
U.S. unemployment was lofty at 7.9 percent last month, while
inflation has remained a bit below the Fed's 2 percent target.
Many factors, from wages to demographics to government
spending, are behind the unemployment rate. The inflation rate
is similarly "noisy," which poses problems if the thresholds are
interpreted as blunt tools.
For example, the Fed is not likely to be satisfied with a
jobless rate that is dropping because Americans are leaving the
workforce en masse, as has sometimes been the case over the last
But these important nuances may not matter to investors who
anticipate the Fed will keep its word and move to raise
short-term interest rates when the threshold nears.
"The market will start pricing in a lot of hikes, then the
yield curve will steepen quite a bit, and equities will tank,
and a lot of the good things that had momentum going into that
move could become undone," predicted Krishna Kumar, a partner at
New York hedge fund Goose Hollow Alpha Advisors.
"It becomes an expectations game," he added.
At the last few Fed meetings, talk of thresholds has heated
Last month, officials weighed the merits of adopting
quantitative thresholds versus a more qualitative description of
what informs its thinking, according to the Fed's minutes. In
the end, "a number of practical issues" were left unresolved,
and Bernanke told staff to do more work on the proposal.
The careful internal deliberations have not stopped some
central bank policymakers from taking their ideas on the road.
Last year, Chicago Fed President Charles Evans pitched
thresholds of 7 percent unemployment and no more than 3 percent
inflation. In the last few months, two other regional Fed
presidents floated their own plans.
Bernanke is set to hold a press conference after the Fed's
Dec. 11-12 policy meeting, but that might be too early for any
"We are probably still a couple of months away from such a
communication strategy," said Michael Feroli, chief U.S.
economist at JPMorgan. In the meantime, he said, the Fed will
probably continue educating the market on how to interpret the