Fed Stands Pat as Expected, Reiterates Support for Credit Markets
The Federal Open Market Committee (FOMC) left the target federal funds rate unchanged at 0%-0.25%. Richmond Fed President Lacker cast the only dissenting vote as he would have preferred increasing the monetary base through purchases of Treasury securities rather than through the credit programs.
The FOMC policy statement noted that the “Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” This part of the message is identical to the December 2008 statement.
Overall, today’s statement presented a broader picture of the economic situation and included some bullish expectations about the economy. By contrast, the December 16 policy statement focused largely on features of the Fed’s new regime. In particular, six aspects of the policy statement were different from the December 2008 announcement. First, significantly slowing global demand was mentioned vs. the December statement that did not mention the global economy. Second, today’s statement noted that “conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions.” Financial market conditions were depicted as “quite strained” in the December statement. Third, the FOMC predicts that “a gradual recovery in economic activity will begin later this year,” and the statement indicated that “the downside risks to that outlook are significant.” Projections about economic recovery were entirely absent in the December statement. Fourth, in December, inflation was expected to “moderate in coming quarters.”
There is notable departure from this view because the Fed now “expects that inflation pressures will remain subdued in coming quarters.” In addition, “the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.” The FOMC is hinting about the possibility of deflation here. The Consumer Price Index is most likely to post a decline in 2009 on an annual average basis, but a persistent deflationary situation is unlikely given the enormous liquidity the Fed has made available to support the financial system.
Fifth, the FOMC indicated that it “is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets.” In December, the communication was that it was evaluating the potential benefits of purchasing longer-term Treasury securities. The objective of purchasing Treasury securities is to bring about a reduction in long rates with the expectation that these lower rates would trickle down to private sector securities such that mortgage rates and other private sector borrowing costs would be less burdensome. However, the initial reaction in the U.S. Treasury market has not been favorable. The 10-year Treasury note yield is trading at 2.65%, as of this writing, up from 2.55% a little before the Fed’s policy statement was available. The 30-year fixed rate mortgage during the week ended January 23 was 5.22%, up from 4.89% during the week ended January 9. As mortgage rates have risen in the last two weeks, mortgage refinancing has declined (see Chart 3).
Sixth, today’s statement has an explicit discussion about the Fed’s balance sheet. As expected the Fed reiterated support of credit markets. In doing so, the Fed’s policy path was summarized as follows: “The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level.” In conclusion, the statement read as: “The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability.” The determination of the Fed to establish a more stable economic environment was embedded in the statement: “The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.”
