Reuters/New York/San Francisco


Tumbling oil prices have strengthened rather than weakened the Federal Reserve’s resolve to start raising interest rates around

midyear even as volatile markets and a softening US inflation outlook made investors push back the timing of the “liftoff.”
Interviews with senior Fed officials and advisers suggest they remain confident the US economy will be ready for a modest policy

tightening in the June-September period, while any subsequent rate hikes will probably be slow and depend on how markets will

behave.
While they are hard-pressed to explain why bond yields have fallen so low, their confidence in the recovery stems in part from

in-house analysis that shows falling oil prices are clearly positive for the US economy.
Internal models also suggest that a decline in longer-term inflation expectations probably does not signal a loss of faith in the

Fed’s 2% inflation goal.
Instead, the models attribute much of the recent decline in market-based measures of inflation expectations to increased investor

confidence that prices will not spiral out of control, officials say.
Policymakers’ public comments reflect that, as they sound unperturbed by what has been a steep drop in recent months. “I am

watching the inflation expectation numbers but not drawing a conclusion that they call for any action or that they change in any

serious way my outlook,” Atlanta Fed President Dennis Lockhart told reporters earlier this week.
Some of those interviewed stressed that in the light of last year’s strong jobs gains waiting until mid-year represented a

cautious approach rather than an aggressive one, allowing the Fed to delay the rate liftoff if needed, particularly if inflation

expectations turned sharply down.
However, with markets increasingly gripped by fears of global deflation and economic stagnation, futures traders now are betting

the Fed will stay pat at least until October, possibly until December.
Yet interviews with the Fed insiders reveal that while they keep an eye on volatile markets they remain confident that unexpected

overseas headwinds will not derail the US economy.
So far, signs of domestic price weakness, such as slow-growing wages, have not shaken the central bank’s faith that inflation

will rebound once energy markets stabilise, the interviews showed. In fact, cheaper gasoline and the boost it gives particularly

to lower- and middle-income households could be just the shot of economic confidence the Fed needs to tighten policy after six

years of near-zero rates.
“We’ve been through enough of these energy price swings...and this volatility can’t go on forever,” Richmond Fed President

Jeffrey Lacker told Reuters in an interview on Monday. “I don’t think we’d have trouble looking through that transitory

phenomenon,” of slightly low inflation, and raise rates, he said. “I don’t think we’d have trouble selling that.”
Lacker has long criticised the Fed’s exceptional monetary stimulus and advocated ending it, but his comments on inflation reflect

the thinking of more centrist Fed policy makers on the subject.
A sharp drop in unemployment to 5.6% and solid economic growth have led most Fed policymakers to pencil in a rate rise this year,

with many eyeing a move sometime in the summer. Most Wall Street economists agree with such timing.
Inflation remains a half-percentage point below the Fed’s 2% target, and could slip more on plunging oil prices and the soaring

dollar. But the Fed expects oil prices to eventually stabilise, the US economy to keep growing despite weakness in Europe and

elsewhere, and inflation to rebound in coming years.  The interviews also showed Fed officials were not overly alarmed by

weakness in some market-based measures of inflation.
Some believe the sharp drop in longer-term borrowing costs, rather than a matter of concern, may be an added reason not to delay

a tightening beyond mid-2015, especially if a “rush to safety” is driving demand for US Treasuries.
With central banks in Europe and Japan looking to ease policy in the face of deflation threat, investors have sold stocks and

commodities and snapped up US debt, driving yields on 10-year and 30-year bonds to or near record lows.
Such low borrowing costs make for exceptionally easy financial conditions in the US, even with the Fed looking to end the era of

near-zero interest rates.
“I think it’s important that the Fed not be so intent on every little movement in these asset market prices that they don’t take

strong enough action,” said former Fed vice-chairman Donald Kohn, who is now a member of the Bank of England’s Financial Policy

Committee. “I certainly expect them to be pretty cautious right after liftoff,” he told Reuters.
The Fed took a small step toward its first rate rise in nearly a decade last month, when rather than saying it would wait a

“considerable time” with tightening it said it would be “patient” — a term Fed chair Janet Yellen suggested meant it might move

in April at the earliest.


The Federal Reserve building in Washington DC. Interviews with senior Fed officials and advisers suggest they remain confident  the US economy will be ready for a modest policy tightening in the June-September period.