What Should Investors Expect from the Federal Reserve?

While earnings season has been the focus of attention in the past couple of weeks, the Federal Reserve is set to take center stage once again.

On Wednesday, the central bank’s Federal Open Market Committee concludes its two-day policy meeting. Officials are set to keep purchasing bonds at a pace of $85 billion per month, but other market-moving changes may occur. Jon Hilsenrath at The Wall Street Journal mentioned in a recent article that the Federal Reserve will discuss changes in regards to its plans for short-term interest rates, which have been at record lows since late 2008.

The central bank has promised that interest rates will stay low until the unemployment rate falls to at least 6.5 percent, so long as inflation remains below an annualized 2.5 percent. However, it could provide a more dovish stance in order to calm any fears in the market.

“At their July 30-31 meeting, Fed officials are likely to discuss whether to refine or revise ‘forward guidance,’ the words they use to describe their intentions for the next few years,” Hilsenrath wrote. “With short-term interest rates near zero, the Fed sees such guidance as an important part of its monetary-policy arsenal. For instance, telling investors that short-term rates will stay low for a long time, Fed officials believe, helps hold down long-term rates, and that encourages borrowing, spending, investing, and growth.”

In order to convey that interest rates will not be raised anytime soon, the Federal Reserve could lower the unemployment rate threshold of 6.5 percent.

Fed Chairman Ben Bernanke has made it clear in the past that the headline unemployment rate does not reflect the entire weakness of the labor market. Many people are being forced to work part time for economic reasons, while others are dropping out of the workforce altogether.

At a conference sponsored by the National Bureau of Economic Research earlier this month, Bernanke said, “I think you can only conclude that a highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy.” He also reminded the market that there will “not be an automatic increase in interest rate when unemployment hits 6.5 percent.”

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In the most recent jobs report, the unemployment rate stayed the same at 7.6 percent in June, though it was slightly higher than expected. The U-6 unemployment rate, which includes everyone in the headline rate plus people who are employed part-time but prefer a full-time position or want work but have stopped looking, jumped from 13.8 percent to 14.3 percent, its highest level in four months.

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