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FOMC: Ready to scale up purchases

Thu, Jan 29 2009, 08:12 GMT
by Peter Possing Andersen, Signe Roed-Frederiksen

Danske Bank A/S

Overview: The Federal Open Market Committee (FOMC) decided at its policy meeting to keep the fed funds rate unchanged in the 0-0.25% range. Moreover, the committee signalled that the fund rate will remain low for a long time. It was decided not to scale up mortgage bond purchase programs or start buying Treasury securities. Richmond Fed President Lacker dissented, preferring to expand the monetary base by purchasing Treasuries rather than through targeted credit programs.

The market was slightly disappointed that the message was not more dovish. Following the announcement the curve twisted with 10-year Treasury yields moving 5-8bps higher and the 2-year segment moving lower by a few bps. Equity markets lost some ground but remained up. The currency market saw the biggest move with the USD strengthening and EUR/USD moving over one big figure lower approaching the 131 level.

Details: The Fed accepted that the economy had weakened further but noted an improvement in several financial markets amid still very tight credit conditions. The growth forecast from the previous meeting was unchanged. The committee continues to expect a gradual recovery later this year. Consequently, incoming data have only served to confirm members' already downbeat outlook.

On inflation the statement moved one step further on emphasizing the deflation risk by noting that there was a "risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term". However, this still suggests that the committee sees a relatively limited risk of a deflationary spiral developing.

The committee "employ all available tools to promote the resumption of sustainable economic growth" and remains biased against expanding its balance sheet further. This could happen either through an expansion of the size or duration of the MBS and agency debt purchase program or by purchasing treasuries. Nothing of this is new compared to the previous meeting.

Assessment & Outlook: The meeting warrants no change to our policy outlook. We expect the Federal Reserve to retain zero rates for a long time. On the short-to-medium term horizon the risk remains of further quantitative easing by expanding the balance sheet. Rate hikes will not be on the agenda before the economy returns to trend and unemployment has peaked.

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Published on  Thu, Jan 29 2009, 08:18 GMT