Wednesday, Sept. 23, 2009
Posted 8 a.m.
The Federal Open Market Committee meets today and the focus will be squarely on the statement they issue afterward. With Fed Chairman Ben Bernanke stating the recession is likely over, the Fed's task now shifts from monitoring a contracting economy to one that is now in the process of recovery. Just when will the Fed need to begin raising interest rates? And how will the Fed go about unwinding their mortgage purchase programs without causing a spike in mortgage rates?
The sustainability of the economic recovery must be unquestioned before the Fed can entertain thoughts of raising interest rates. We’re not there yet, as the recovery is widely seen as tentative or easily derailed if an unexpected shock arises. But the remaining months of 2009 will help answer the sustainability question, which in turn will dictate how and when the Fed changes its tune on interest rates. We won't get any hints on that front at this meeting, and the Fed is likely to retain the "exceptionally low levels of the federal funds rate for an extended period" phrasing of recent meetings.
For now, the question that matters to homeowners, homebuyers, and home sellers is how the Fed begins to position for 2010 in regard to the mortgage market. With the Fed gobbling up $1.25 trillion of mortgage-backed securities in 2009, making them not just the biggest single buyer but the majority buyer, the state of the mortgage market doesn't lend itself to the Fed quitting cold turkey. Therefore the Fed is likely to wean markets off their support, similar to the tact taken with $300 billion in Treasury purchases that were set to expire in September but were extended through October. Expect to see an extension into 2010, with the Fed cautiously withdrawing from the market. This may be a process deliberately void of many details, giving the Fed the latitude to tailor their purchases to the needs of the market and the level of mortgage rates.
If this is the path that will be taken, expect very little if any mention of it following this FOMC meeting. Only if the Fed were withdrawing cold turkey would they need to give markets a heads-up well in advance. The less said at this juncture, the better.
Finally, let’s talk about inflation. High unemployment, slack consumer demand, and excess capacity are often cited in the case against inflation. The Fed points to “substantial resource slack” as containing both cost pressures and inflation “for some time.” But this ignores the prospect of importing inflation via a weaker dollar. Seen the dollar lately? The greenback looks like it has a touch of the swine flu with the dollar hitting the lowest levels in one year against an index of foreign currencies.
Economic recovery means the dollar won’t be needed for safe haven shelter as it has in the past 12 months. Soaring government debt and the prospect of interest rates remaining lower, for longer, than overseas counterparts mean inflation will come via imports, rather than the "too many dollars chasing too few goods" scenario.
And speaking of importing inflation, let's look at how oil prices have whipsawed the headline inflation figures, with the Consumer Price Index down 1.5 percent in the past year. (Core inflation, by the way, is still up 1.4 percent in the past 12 months). One year ago, the average cost of a gallon of gasoline was $3.83, which makes a nice year-over-year comparison and helps push the inflation rate into negative territory. But we won’t have that same benefit in December when the year-ago figure drops to $1.59.
Bottom line, even with high unemployment, weak consumer demand, and excess capacity, the headline inflation figures will make a turn to the positive side of the ledger once the favorable year-ago comparisons on energy prices disappear. And a weaker dollar won’t help.