As expected, the Federal Reserve left the federal funds rate unchanged at its meeting today. Below, we present statements from the current meeting along with statements from the late January meeting, with my commentary and interpretation (translation?) interspersed on a paragraph by paragraph basis.
“Information received since the Federal Open Market Committee met in January suggests that economic activity has continued to strengthen and that the labor market is stabilizing. Household spending is expanding at a moderate rate 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 is declining, housing starts have been flat at a depressed level, and employers remain reluctant to add to payrolls.
“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 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.”
The Fed’s language is slightly more upbeat on the labor market — stabilizing implies a flat scenario, rather than the “just falling apart more slowly” language from the January meeting. The difference between household spending being constrained by high unemployment rather than being constrained by a weak labor market is pretty much a mater of semantics, not any real change in the economy.
The Fed is far more upbeat about the business investment side of things, particularly when it comes to equipment and software. It paints a negative picture on construction, though, both residential and non-residential (commercial real estate). It notes that employers are still not hiring. That is not really a contradiction to the earlier statement in the paragraph about the employment picture stabilizing.
The current problem in the economy (at least from an employment point of view) is the lack of new job creation, not an excessive rate of job destruction and layoffs. The Fed sees a gradual recovery, and one where inflation is not a serious issue.
Remember that the Fed has a dual mandate. It is supposed to fight inflation, but it is also supposed to foster full employment. Keeping the fed funds rate low means that it is more concerned with the employment part of its mandate right now than it is with the inflation side, and rightly so.
“With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”
“With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”
Fed-speak for “Inflation, forget about it, its not a problem.” Not so much as a comma changed from last time.
“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 has been purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt; those purchases are nearing completion, and the remaining transactions will be executed by the end of this month.
“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 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.”
They kept the key phrase “to warrant exceptionally low levels of the fed funds rate for an extended period.” That was the key phase that people were looking for. It was also the cause of the objection that Tom Hoening, the head of the St. Louis Fed, hadin both last meeting and this one.
I think that Mr. Hoening is dead wrong on this. Inflation is not the problem, high unemployment and low rates of capaicity utilization, particularly in manufacturing, is the major problem in the economy, and that is not about to change any time soon. Any indication that the Fed was about to raise short-term rates would have a detrimental impact on both the markets and the economy.
“In light of improved functioning of financial markets, the Federal Reserve has been closing the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities and on March 31 for loans backed by all other types of collateral.”
“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 will 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.”
While the Fed is not about to raise the fed funds rate, it is tightening up monetary policy in other ways. Due to the severity of the financial crisis that started 18 months ago with the fall of Lehman Brothers (OK, one can make a good case that it started before that, and the mistakes that caused it happened years before things came to a head in September 2008) was so severe that even a 0% Fed funds rate was not enough to provide the sort of liquidity needed to put out the raging wild fire that was the panic.
The Fed had to invent all sorts of different ways to inject liquidity into the system. It has been shutting those down, with the closure of several of them discussed last meeting and this time announcing that the last of them, the TALF, is on schedule to disappear in stages, with it mostly shut down by the end of the month.
No mention was made this time of the program to purchase $1.25 trillion in agency-backed mortgage-backed securities. That program is substantially complete and will finish up by the end of the month. The program amassed about 25% of all the mortgages backed by Fannie Mae (FNM) and Freddie Mac (FRE).
It will be extremely interesting to see what happens to mortgage rates after the program is finished. Based on the historical relationship between mortgage rates and the 10-year Treasury bill, we should see mortgage rates rise by about 50 basis points. However, the rate at which they have been buying them has slowed down significantly, so there has been a gradual easing of the distortions cause by the massive Fed buying program.
“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 the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.”
“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.”
Tom Hoening was the lone (and, to my mind, wrong) voice of opposition to the policy.
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.
