The Federal Reserve Open Market Committee announced today it would continue its existing efforts to boost the U.S. economy, including keeping the federal funds target rate near zero percent “at least through mid-2013.”
But the FOMC held off on announcing any new initiatives, perhaps in part because of some positive economic news since its last meeting in September.
Federal Reserve Chairman Ben Bernanke did express concerns about continued weakness in the job market and European debt crisis, which became more complicated this week with the announcement that Greece may hold a national referendum that could obstruct European attempts at addressing the crisis.
Pausing to take a breath
It was too soon to expect the Federal Reserve to take more actions, considering it unveiled a monetary easing program called Operation Twist just a month and a half ago, says Paul Wachtel, professor of economics at the Stern School of Business at New York University. That program saw the Fed selling short-term bonds in its portfolio and using the proceeds to buy long-term bonds, a process designed to yield lower rates on long-term loans such as mortgages.
“The economic data — employment, orders, sales, (gross domestic product) — (look) a little bit better than it looked at the last meeting,” Wachtel says. “I think it’s too soon for them to back off something like Operation Twist.”
Positive economic data, including better-than-expected growth of 2.5 percent in gross domestic product and private-sector jobs growth, seem to have influenced the Fed to stand pat. From the Fed’s statement:
Information received since the Federal Open Market Committee met in September indicates that economic growth strengthened somewhat in the third quarter, reflecting in part a reversal of the temporary factors that had weighed on growth earlier in the year.
The sheer volume of monetary easing by the Fed in recent years also may have been a factor, says Lewis Spellman, professor of finance at University of Texas in Austin.
“The Fed has run out of bullets. Four years ago when we started the mortgage meltdown, its balance sheet was about $900 billion,” Spellman says. “It’s now three times that.”
That balance-sheet expansion has been driven by the Fed’s massive purchases of securities in the open market known as quantitative easing, or QE, Spellman says.
More QE to come?
However, the Fed did hint that it would take further action if the U.S. economy showed signs of worsening. That action could take the form of a third round of QE, says Tom Porcelli, chief U.S. economist for RBC Capital Market in New York.
“Twist just started so I think it’s premature for the Fed, at this stage, to want to engage in any additional policy easing,” Porcelli says. “However, I don’t think there’s any question that QE is in tow.”
Porcelli says a chorus of Fed officials, including Federal Reserve board members Janet Yellen and Daniel Tarullo, have cited the housing market as an impediment to recovery.
“They all seem to be leading us down this path of additional policy measures,” he says, culminating in what could be a new round of quantitative easing in early 2012.
Bottom line for consumers
What remains to be seen is how much the Fed’s easing efforts will impact consumers. Mortgage borrowers have clearly benefited, as mortgage rates have fallen to record lows since the beginning of Operation Twist. Still, low rates may not be enough to help boost the housing market, Wachtel says.
“The issue is with so many other problems in the mortgage market — people’s difficulty in refinancing, the unwillingness of banks to encourage refinancing, the inability of banks to write down existing mortgages when they’re underwater and allow people to refinance to the current value of the house.
“All those kinds of structural and even legal issues are really what ties up the mortgage market,” Wachtel says. “The Fed is not involved in any of that.”
For savers, the Federal Reserve’s continued push for lower interest rates has been a hard pill to swallow. Operation Twist could be particularly hard on investors in long-term certificates of deposit, Wachtel says.
“The Fed is basically buying long-term Treasuries, so the rates should go down. If rates are going down on longer-term Treasuries, then banks’ CD rates of longer terms should go down in line with that,” he says.
As for the bigger economic picture, some experts doubt the Fed’s efforts will have much of a positive effect on consumer spending or overall economic growth.
“We have domestically within our economy too many consumers who are burdened with debt, and monetary policy works by inducing them to go to banks and, with cheaper rates, borrow more and spend more,” says Spellman. “But they are already trying to work their debt limits down.”
Still, the Fed doesn’t want to be seen as sitting on its hands if the U.S. economy slides into a second recession.
“I think it’s going to be very difficult for the Fed to jump-start economic activity, and the truth is, they probably recognize that. However, that’s not going to stop them from continuing to act,” Porcelli says. “The Fed would not want to be accused of sitting idly by while economic activity deteriorates.”
The Federal Reserve Open Market Committee today elected not to begin any new monetary easing but did hint at future actions should the economic outlook continue to show weakness.
Fed Chairman Ben Bernanke reiterated his commitment to keeping the federal funds rate target near zero for the foreseeable future, citing concerns about the moribund U.S. economy and the continued debt crisis in Europe.
Federal Reserve watchers hadn’t expected much in the way of new initiatives, as this most recent meeting came on the heels of the announcement of an easing program known as Operation Twist announced at the Sept. 21 meeting of the FOMC. That program seeks to bring down rates on long-term loans such as consumer mortgages by selling some of the Fed’s short-term bond portfolio and use the proceeds to purchase long-term bonds such as mortgage-backed securities and long-term corporate bonds.
“The economic data — employment, orders, sales, (gross domestic product) — (look) a little bit better than it looked at the last meeting,” says Paul Wachtel, professor of economics at the Stern School of Business at New York University. “I think it’s too soon for them to back off something like Operation Twist.”
Some positive data had also begun to emerge in the run-up to the meeting, including a better-than-expected 2.5 percent GDP growth and a gain of 110,000 private sector jobs in ADP’s National Employment Report for October. That positive data may have pushed the Fed to stand pat for now.
Fed day coverage
Nov. 2, 2011
The Federal Reserve’s rate-setting committee meets this week, a two-day affair on Tuesday and Wednesday, culminating in the third press conference scheduled for this year.
Unlike the September meeting in which nearly all the Fed-watching wonks were certain the Federal Open Market Committee, or FOMC, would embark on Operation Twist, the expected outcome of this month’s meeting is still something of a question mark.
One thing is certain: The federal funds target rate will remain close to zero. That means rock-bottom rates on loans for those who can get them and bottom-of-the-barrel yields on savings for everyone.
With the economic tea leaves pointing in a positive direction on some fronts and two consecutive meetings in which significant monetary policy action was taken, the FOMC is most likely to take a wait-and-see approach at this meeting.
In fact, with the release of the third-quarter gross domestic product on Thursday of the preceding week, the Fed may find the soft patches in the economy a bit firmer than they seemed at the September meeting.
“I think there has been a change in the economic landscape with the release of the third quarter GDP. It was 2.5 percent, almost double the previous quarter, the best result in one year. I think this will give the opportunity to the Fed to pause and basically buy some more time,” says Adolfo Laurenti, deputy chief economist at Mesirow Financial in Chicago.
Of course, the economy is still plagued by multiple problems, notably housing and unemployment.
The Federal Reserve has more arrows in its quiver. If the committee does decide the economy needs more accommodation, these are some of its options.
Tinkering with forward policy guidance
In September, the FOMC took the unprecedented step of explicitly stating that the federal funds target rate will remain close to zero until mid-2013.
Since then, however, some FOMC members — Charles Evans, president of the Chicago Federal Reserve Bank, and Federal Reserve Governor Janet Yellen — have publicly stated that using specific inflation and unemployment numbers as barometers could provide more clarity. For example, “saying we’re not going to raise the federal funds rate above zero until the unemployment rate goes under a certain level” might be a better gauge than a future time frame, says Gregory Daco, principal economist at IHS Global Insight, an economic forecasting and analysis firm.
Reducing or eliminating interest paid on excess reserves
Despite multiple attempts at reviving the moribund housing sector by regulators and all levels of government, nothing has really worked so far.
One problem is that no matter how low rates remain, the people who want to buy houses are generally not able to get approval for loans, and the people to whom the banks would prefer to lend are not biting.
One way the Fed may be able to prod banks into lending is by scaling back or eliminating the interest paid on the excess reserves banks park at the Federal Reserve.
If the Federal Reserve stops paying interest on excess reserves, “then banks will not have an incentive to keep all that cash as reserves and instead will now have a greater motivation and incentive to lend it out,” says Bernard Baumohl, chief global economist at the Economic Outlook Group in Princeton, N.J.
“These days, the only way banks can make any money is to actually lend money out to the public and make a profit on the difference between the cost of borrowing and the rate that they charge. I think the Fed is encouraging banks to do that,” he says.
Buy more mortgage-backed securities
The Fed may try to target the housing sector directly through monetary policy. The way it would do that is through additional purchases of mortgage-backed securities, or MBS.
In a recent speech, Fed Governor Daniel K. Tarullo stated that a large-scale MBS purchase program “could also have more direct effects on the housing market. By increasing demand for MBS, such a program should reduce the effective yield on those MBS, which in turn should put downward pressure on mortgage rates.
“The aggregate demand effect should be felt not just in new home purchases but also in the added purchasing power of existing homeowners who are able to refinance,” he said in the Oct. 20 speech at the World Leaders Forum at Columbia University.
“To a certain extent, they are trying to influence lending by the banks. The move to make it easier to refinance is trying to free up funds of individuals. If people could go back and refinance at a lower interest rate, they could have more discretionary spending and stimulate the consumption side of the economy,” says Jerry Lynch, professor of economics at Purdue University.
One way the Federal Reserve could target the housing sector without expanding the balance sheet would be through more purchases of MBS in Operation Twist and fewer purchases of longer-dated Treasuries, Baumohl says.
Yellen and William Dudley, president of the Federal Reserve Bank of New York, have indicated that a third round of quantitative easing is on the table should the economic situation warrant it.
Though he voted against the actions taken at the previous two meetings, in a recent speech Federal Reserve Bank of Philadelphia President Charles I. Plosser outlined the conditions he feels would deserve further action from the Fed.
“If deflationary fears were to become a real threat again and we saw signs that the economy was moving to a sustained disinflation with declining inflation rates and inflation expectations, then we would need to consider further action to stabilize inflation expectations,” he said in an Oct. 12 speech at the Wharton School at the University of Pennsylvania.