The Federal Reserve decided to keep the Fed Funds rate at its historically low level, and noted that growth was starting to pick up and there was very little threat of near-term inflation. The current statement and the one from the previous meeting (8/12) are presented below, along with my analysis of the statements and the differences between them.
“Information received since the Federal Open Market Committee met in August suggests that economic activity has picked up following its severe downturn. Conditions in financial markets have improved further, and activity in the housing sector has increased. Household spending seems to be stabilizing, but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth and tight credit. Businesses are still cutting back on fixed investment and staffing, though at a slower pace; they continue to make progress in bringing inventory stocks into better alignment with sales.
“Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will support a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.”
“Information received since the Federal Open Market Committee met in June suggests that economic activity is leveling out. Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment and staffing but are making progress in bringing inventory stocks into better alignment with sales.
“Although economic activity is likely to remain weak for a time, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.”
The key difference is that the Fed sees the economy picking up rather than merely leveling out. They note the continued improvement in the financial markets. This is true not only for the stock market, which is up almost 7% since the last meeting, but also in things like credit spreads.
They note the upturn in the housing market, which they did not do last time around. They note that fixed investment is going down, but at a much slower rate, which is the first step towards a turnaround. Most of the rest of the first paragraph is the same. This is the most upbeat Fed statement in a long time.
“With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.”
“The prices of energy and other commodities have risen of late. However, substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.”
The Fed seems ever less worried about near-term inflation than last time around. While I think that we will still see upward movement of commodity and energy prices (well obviously not today, with oil down hard following higher-than-expected inventory levels). This could lead to higher headline inflation, but low core inflation.
There is simply too much slack in the economy to see inflation rocket higher. There is no way for the wage side of a wage price spiral to take hold. Also keep in mind that rent and owners equivalent rent make up almost 40% of core CPI, and it seems more likely that rents will fall than rise over the next year or so.
“In these circumstances, the Federal Reserve will continue to employ a wide range of tools to promote economic recovery and to preserve price stability. 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 are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
“To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt. The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010.
“As previously announced, the Federal Reserve’s purchases of $300 billion of Treasury securities will be completed by the end of October 2009. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.”
“In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. 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 are likely to warrant exceptionally low levels of the federal funds rate for an extended period.
“As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities.
“To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions, and anticipates that the full amount will be purchased by the end of October. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.”
Fed Funds are not going up — not now, not next meeting, or the meeting after that. I would be greatly surprised if they were to raise them at any time before the fourth quarter of 2010, and then only gradually and cautiously.
Historically, the Fed does not raise rates until well after the unemployment rate has peaked, even in a shallow recession. This one has been anything but shallow. It is likely that the unemployment rate will not peak until well into next year and will be well over 10% when it does. It would be very irresponsible for the Fed to strangle the recovery by moving too soon.
The size of the asset buying programs was maintained, but they decided to stretch out the mortgage-backed and agency paper buy until the end of the first quarter, rather than by the end of the year. This would prevent a disruption in the market from the Fed no longer being in the market.
The slowdown is a bit of a concession to those who think that the Fed has been going overboard on its easy money policy, but not much of one. By the end of the program, the Fed will own almost 25% of all the Fannie (FNM) and Freddie (FRE)-backed paper outstanding.
The big question for next year is: what are they going to do with all that paper. At what point do they start feeding it back out into the market, or do they just plan to sit on it forever? Stretching out the program will also help the housing market so that the end of the artificial price support for mortgage backed paper, and thus artificially low mortgage rates, does not come right at the same time as the end of the “first time” home buyer tax credit.
“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.”
“Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.”
Everyone agreed.
Overall this was a very upbeat Fed statement. Growth is coming back, no near-term threat of inflation and the financial markets are improving. Low interest rates for as far as the eye can see. I suspect that the market should like it.
The foreign exchange market might have been looking for some evidence that the Fed was going to reverse course and start to tighten up, but they didn’t get it. Pressure on the dollar is more likely to cause headline inflation to go up than core inflation to rise. I think the Fed is more concerned with core inflation.
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