federal reserve

Get ready to parse the Fed's words

Monday, Nov. 2, 2009
Posted 8 a.m.

Now that we have validation that the economy is growing again -- as evidenced by the first look at third quarter GDP -- is it time for the Fed to start reeling in the lines of liquidity? Expect a whole lot more debate about that, inside and outside the halls of the Federal Reserve, surrounding the Nov. 3 to 4 meeting of the Federal Open Market Committee.

The Fed has begun to test the unwinding of some of its other liquidity programs already, but the real significance to consumers revolves around expectations for eventual rate hikes and the Fed's support of the mortgage market.

The Fed's mortgage purchases will taper off through the end of 2010's first quarter after having extended the timeframe by an extra three months, but not increasing the amount of the buybacks. But the mortgage market remains almost entirely dependent upon government support of one form or another -- the Fed buying mortgage-backed debt to keep rates low and government owned entities Fannie Mae, Freddie Mac and the FHA guaranteeing mortgages against default.

With the Fed having purchased 80 percent of all mortgage debt issued this year, just how much will it be able to slow the pace in the next five months without a surge in mortgage rates resulting? Is it really feasible to go from flat-out to a dead stop in such a short period of time? That's what the Fed will be contending with at this and upcoming meetings.

The tent of record low short-term interest rates will be the last to be folded up and we're still months of economic improvement away from a rate hike. But pressure will build for the Fed to say something long before it does something and for two reasons. The first is to prep the markets for the inevitable increase and do it without spooking anyone. Secondly, a swooning dollar, rising commodity prices, and increased angst about potential inflationary consequences have the potential to accelerate and force the Fed's hand into raising rates sooner than desired.

This can be delayed -- or perhaps avoided altogether -- by laying the groundwork for future rate hikes now. A tweak to the phrasing about maintaining the exceptionally low federal funds rate "for an extended period" could be in order, or we could see a complete rewrite with the Fed communicating that rates will remain low even once they commence increases in the federal funds rate. When you're starting from zero to 0.25 percent, you can raise rates a few times and only move from "exceptionally low" to "low" or "accommodative."

Silly as it sounds, this parsing of words is the name of the game and Ben Bernanke's thesaurus will be as significant to the movement of interest rates as the Fed's checkbook over the next several months.

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