The Fed just wrapped up its last FOMC meeting of the year, and as expected it did not change the fed funds rate. The policy statement was substantially the same as the one they released after the last meeting in early November. While the Fed Funds rate is not going up anytime soon, the Fed looks like it is ending the loosening programs that went above and beyond a 0% short-term interest rate. My reaction and translation follows each matched paragraph.
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.
Information received since the Federal Open Market Committee met in September suggests that economic activity has continued to pick up. Conditions in financial markets were roughly unchanged, on balance, over the intermeeting period. Activity in the housing sector has increased over recent months. Household spending appears to be expanding 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.
They noted that the job market is finally showing some positive signs, something that on the margin makes this statement a bit more hawkish than the last one. They added in the term “moderate rate” with regards to household spending, which to my ear sounds softer than just expanding.
They noted a better tone to financial market conditions. Overall, I would say the Fed sounds a bit more upbeat about the economy now than they did in the November meeting.
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.
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.
No change at all — the Fed still realizes that the biggest problem the economy faces is slow growth and the associated high unemployment rate and low rates of capacity utilization.
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.
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, 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 will purchase a total of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt.
In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and 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. 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.
The quantitative easing program — buying up the Fannie Mae (FNM) and Freddie Mac (FRE) mortgage-backed securities and debt — is now about 85% complete, and it does not sound like they are planning on extending it. Recently the pace has been about $17 billion a week, and if they were to finish the program at the end of March as they indicate, that means that on average they would be spending about $12 billion a week.
The Fed buying has probably lowered mortgage rates by about 0.50% from where rates would otherwise be (based on historical spreads of mortgage rates over the 10-year T-note). How much of a hit the housing market will take if mortgages were to rise by that amount after they finish up is still and open question.
They kept the key phrase of “exceptionally low levels of the federal funds rate for an extended period.” They did, however, drop the language of using a wide range of tools. In other words, they are not going to try to pull another rabbit out of their hat to try to increase liquidity further in the face of the zero boundary on the fed funds rate. The Fed thinks we have successfully escaped from the liquidity trap.
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.
Note that this whole section is new. Essentially, the Fed is looking for a return to normality, and letting the alphabet soup of special lending facilities die a quite death. They did their job and prevented a total implosion of the financial system (the partial implosion was nasty enough) and the Fed thinks that it can now rely on its conventional, long-standing tools to keep the financial plumbing of the economy unclogged. While this is not close to a raising of the fed funds rate, it will effectively be a bit of a monetary tightening.
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.
While the Fed made it clear that they are NOT going to raise the fed funds rate anytime soon, they are going to take some steps to bring things back to normal. Effectively, by not embarking on another spree of quantitative easing, the Fed will be a bit tighter than it has been. It clearly sees some significant improvement in the economy, and feels that it can now drop the innovative emergency measures they put in place during the collapse last year.
I would interpret the phrase “extended period” to mean a minimum of six months, and more likely a year. Historically, the Fed has always waited until well after the Unemployment rate had peaked to start to raise the fed funds rate. Last time for a year past the peak, and the time before that for 18 months. Both those recessions were extremely mild relative to the one we are just climbing out of now.
I agree that inflation, particularly core inflation, is going to stay low for the foreseeable future. The low fed funds rate will put upward pressure on the prices of commodities (and thus we might see a pick-up in headline inflation) and downward pressure on the dollar. While both of those effects imply higher inflation, there is more than enough slack in the system and other deflationary forces elsewhere in the economy to offset those pressures.
The very low fed funds rate also means that the yield curve will remain extremely steep. This will help allow the banks to earn their way out of their balance-sheet mess. The money from the big net interest margins will help pay for the big loan losses that many of them will still have to take, most notably on commercial real estate, but also still on residential mortgages if we see another wave of foreclosures in 2010 (as I think is likely).
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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