The Federal Reserve decided to leave the Fed Funds rate unchanged at a range of 0 to 25 basis points, just like everyone expected them to do. Below are the current statement and the December statement, along with my analysis of the changes and commentary interspersed.
“Information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating.
“Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth and tight credit. Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls. Firms have brought inventory stocks into better alignment with sales.
“While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates 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 November suggests that economic activity has continued to pick up and that the deterioration in the labor market is abating. The housing sector has shown some signs of improvement over recent months.
“Household spending appears to be expanding at a moderate rate, though it remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit. Businesses are still cutting back on fixed investment, though at a slower pace, and remain reluctant to add to payrolls; they continue to make progress in bringing inventory stocks into better alignment with sales.
“Financial market conditions have become more supportive of economic growth. 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 contribute to a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability.”
Note the deletion of the sentence about the housing sector showing signs of improvement. After today’s new home sales numbers, that is understandable.
They are slightly more upbeat about household spending in that they dropped the modifier “appears to be” when talking about the moderate expansion of spending. Much more upbeat about the pace of business investment in equipment and software, which if true and sustainable is a major plus for the economy, but the language is still tentative. Then again, it is better to see signs of actual expansion rather than just a slowing in the rate of decline.
For the first time they mention that investment in structures is contracting…well, stop the presses, folks! Seriously, this is far from really news. The Fed seems to think the inventory adjustment is over, and it may well be; inventory investment will probably be a huge factor in the 4Q GDP report due out on Friday morning.
“With substantial resource slack continuing to restrain cost pressures and with longer-term inflation expectations stable, inflation is likely to be subdued for some 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 Fed expects a very gradual economic improvement, and that given the massive amounts of slack in the system, inflation should not be a problem. The Fed says “substantial,” but that is just classic Central Banker understatement — unemployment is at 10% and capacity utilization, while improving from record low levels, is still roughly at it worst level ever seen prior to this downturn (although to be fair, the capacity utilization data only goes back to 1967). Under such conditions, it is unlikely that inflation will be able to gain much traction.
“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.
“To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the Committee is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter. The Committee will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets.”
“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.
“To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. In order to promote a smooth transition in markets, the Committee is gradually slowing the pace of these purchases, and it anticipates that these transactions will be executed by the end of the first quarter of 2010. 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.”
“…Are likely to warrant exceptionally low levels of the federal funds rate for an extended period…” is the key phrase everyone is looking for in this report — no change, and that is good news. The Fed would be totally ignoring its mandate to foster full employment conditions if it were to raise rates now, with inflation very subdued and likely to remain that way while the economy faces 10% unemployment and 17% underemployment (U-6) rates.
The agency mortgaged-backed security buying program is about 92% complete and should be done by the end of March, so the slowing is sort of by necessity, or they would have had to have moved up the completion data. This program has helped hold down mortgage rates and thus has supported the housing market. Major questions remain about what happens to mortgage rates once the Fed buying pressure is off of the market.
“In light of improved functioning of financial markets, the Federal Reserve will be closing the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility on February 1, as previously announced. In addition, the temporary liquidity swap arrangements between the Federal Reserve and other central banks will expire on February 1.
“The Federal Reserve is in the process of winding down its Term Auction Facility: $50 billion in 28-day credit will be offered on February 8 and $25 billion in 28-day credit wil be offered at the final auction on March 8. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30 for loans backed by new-issue commercial mortgage-backed securities and March 31 for loans backed by all other types of collateral. The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.”
“In light of ongoing improvements in the functioning of financial markets, the Committee and the Board of Governors anticipate that most of the Federal Reserve’s special liquidity facilities will expire on February 1, 2010, consistent with the Federal Reserve’s announcement of June 25, 2009. These facilities include the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility. The Federal Reserve will also be working with its central bank counterparties to close its temporary liquidity swap arrangements by February 1.
“The Federal Reserve expects that amounts provided under the Term Auction Facility will continue to be scaled back in early 2010. The anticipated expiration dates for the Term Asset-Backed Securities Loan Facility remain set at June 30, 2010, for loans backed by new-issue commercial mortgage-backed securities and March 31, 2010, for loans backed by all other types of collateral. The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth.”
No real change here. The Fed is going to keep the Fed Funds rate near zero, but is pulling in its horns a bit on some of the “innovative” programs they put in place during the emergency a year ago. They just provided a bit more detail on the wind-down.
“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 economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.”
“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.”
Hoening was not a voting member last time. He is one of the more hawkish Fed members. I personally think he is dead wrong about conditions being sufficiently improved to start thinking about raising rates, or sending signals to the market about doing so.
Financial conditions might have improved, but they have been in better shape for awhile now. For example, the TED spread is back down to normal levels and has been for months. Yes, Goldman Sachs (GS) and J.P. Morgan (JPM) are back to minting money, but Main Street is still in a world of hurt.
As for Economic conditions, I would suggest Mr. Hoening get out of his office a bit more often and talk to a few ordinary Americans. I cordially invite him to Dayton, Ohio to see why we are in no condition whatsoever to be stepping on the monetary brakes.
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.
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