The Federal Reserve, as expected, left the Federal Funds rate at a range of between 0% and 0.25% where it has been since December 2008, at the height of the financial meltdown. While lots of attention is being focused on this meeting, and the statement that accompanies it, the main issue is if the Fed will change its language regarding the state of the economy and if it is prepared to take any unconventional steps to help the economy along.
The Fed took a half step in that regard by deciding to reinvest the cash flows from the mortgage-backed securities it bought earlier this year, rather than letting them roll off. While I would have preferred that they undertake quantitative easing right now, this step is welcome, and lays the ground work for taking more aggressive steps in the future.
However, with the Fed Funds rate up against the zero boundary, don’t expect too much impact from the Fed’s moves. To some extent now they are at the point where they are pushing on a string. Fiscal stimulus would be much more effective, but the economy can use the help from whichever quarter that will do so.
Below I present the current statement and the statement from the end of the last Fed meeting on June 23rd. I do so paragraph by paragraph, and interpret/translate in between.
“Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months. Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.
“Business spending on equipment and software is rising; however, investment in nonresidential structures continues to be weak, and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Bank lending has continued to contract.
“Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.”
“Information received since the Federal Open Market Committee met in April suggests that the economic recovery is proceeding and that the labor market is improving gradually. Household spending is increasing but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.
“Business spending on equipment and software has risen significantly; however, investment in nonresidential structures continues to be weak and employers remain reluctant to add to payrolls. Housing starts remain at a depressed level. Financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad. Bank lending has continued to contract in recent months.
“Nonetheless, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time.”
On just about every count the language describes a weaker economy than it did following the meeting in June. Instead of the economic recovery proceeding, it has slowed.
“Measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”
“Prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”
No mention of the commodity side of inflation, just that inflation has headed lower. It is doing so from very low levels already. Frankly, I’m not sure what long-term measures of inflation expectations they are talking about; the implied inflation from the spread between regular t-notes and the TIPS inflation protected ones have declined significantly in recent months. The real danger is deflation, not inflation right now.
“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
No change in the exceptionally low levels for an extended period language. That has been there for all of this year, and so not changing it is not a surprise, even though one of the members has repeatedly objected to it.
“To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level by reinvesting principal payments from agency debt and agency mortgage-backed securities in longer-term Treasury securities. The Committee will continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.”
No equivalent paragraph in the last statement. However, this is the big news this time around.
The Fed had bought up $1.25 Trillion in mortgage-backed paper earlier this year. Some of that paper will mature, and of course it throws off some cash flow. Low mortgage rates also encourage people to refinance, with cases faster prepayments.
Now the Fed, instead of letting it roll off, is going to reinvest the proceeds. This stops the passive contraction in the money supply that would have occurred if the Fed were going to simply let the stuff roll off when it matured.
It also significantly pushes back its exit strategy from the big increase in the size of its balance sheet since the crisis started. This also sets the stage for a more aggressive course of quantitative easing in the future. This is just a half step, but a welcome one.
“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”
“The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”
Standard Fed boilerplate that is in every statement they put out.
“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.
“Voting against the policy was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee’s ability to adjust policy when needed.
“In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve’s holdings of longer-term securities at their current level was required to support a return to the Committee’s policy objectives.”
“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; James Bullard; Elizabeth A. Duke; Donald L. Kohn; Sandra Pianalto; Eric S. Rosengren; Daniel K. Tarullo; and Kevin M. Warsh.
“Voting against the policy action was Thomas M. Hoenig, who believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability, while limiting the Committee’s flexibility to begin raising rates modestly.”
Tom Hoening is a bit of a nut job. He wants to sit back and do nothing and possibly indicate that the Fed is going to tighten up monetary policy in the face of 9.5% unemployment, extremely low levels of capacity utilization and no signs of inflation whatsoever.
With fiscal policy turning more restrictive as the stimulus wears off and State’s being forced to raise taxes and fees and cut services, it is downright silly to think that this would be a good time to reign in monetary policy, unless of course your objective was to push the economy back into recession.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.
