mortgage

Fed keeps the status quo

Federal Reserve building from the left, blue skies
Highlights
  • Fed continues policy of low short-term rates, hurting savers.
  • Fed's policies are designed to drive long-term rates lower.
  • Critics contend Fed policies haven't helped economy.

The Federal Reserve's rate-setting committee announced today that it will keep the federal funds target rate near zero. The decision was not a surprise. The Federal Open Market Committee, or FOMC, chose not to alter its controversial quantitative easing program, dubbed "QE2."

"Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions," the Committee said in its policy statement. It also said that economic conditions may warrant "exceptionally low levels" for the federal funds rate for "an extended period."

The Fed added that it will maintain "its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011."

New members, new direction on QE2?

The members of the FOMC -- consisting of the seven members of the Federal Reserve Board of Governors, the New York Fed president and four Reserve Bank presidents that serve one-year terms on a rotating basis -- meet at least eight times a year to decide the course for monetary policy and short-term interest rates. Its dual Congressional mandate is to promote maximum employment and stable prices.

Two of the new members on the panel, Philadelphia Fed President Charles Plosser and Dallas Fed Chief Richard Fisher, are known critics of quantitative easing, an asset-buying plan that involved, in its first round, the injection of $1.7 trillion into the banking system with the purchase of longer-term securities. In November, the FOMC voted to continue reinvesting principal payments from its securities holdings as well as purchase an additional $600 billion in longer-term Treasury securities through the end of June.

The purpose of the program is to push down or keep long-term interest rates low and entice investors into riskier assets, such as stocks. Critics have argued that the asset-buying strategy could lead to excessive inflation.

However, Plosser and Fisher did vote for the monetary policy action announced today.

Still, the status-quo decision this week regarding QE2 was expected. "At this point, they're rather pleased with the results and they don't want to rock the boat," says Greg McBride, senior financial analyst for Bankrate.com. He cites recent stock market gains and stabilization in mortgage rates as signs of QE2's influence.

The Fed is likely to stay the course with quantitative easing until we see a sustained recovery in housing, stabilization in domestic and global financial markets and the end of high unemployment, according to Ken Thomas, a lecturer in finance at the University of Pennsylvania's Wharton School.

"We're still far from a situation where we could remove the easing," he says.

Normally, the Federal Reserve's policy-making panel would lower the federal funds rate to stimulate economic growth, but the target rate has been close to zero since December 2008, leaving little room for further reductions.

What the Fed's rate decision means for you

The target for the federal funds rate, the interest rate at which depository institutions lend money to each other overnight, will stay in a range between zero and 0.25 percent. A change in the federal funds rate affects other short-term rates, such as the prime rate. The prime rate runs 3 percentage points above the federal funds rate and will remain at 3.25 percent.

Committee members aren't likely to shift gears anytime soon. "The Fed is in no hurry to raise short-term rates," McBride says. "If it happens, it won't happen until the fourth quarter."

As a result, savers will likely continue to see low yields on certificates of deposit, money market accounts and regular savings accounts throughout the year. If the economy continues to improve, McBride says CD yields -- particularly those with long-term maturities -- could as well, but the returns are "not going to knock anybody's socks off."

Borrowers will technically benefit, because prime rate-triggered rate increases on home equity lines of credit and variable-rate credit cards won't occur. However, other factors could influence rates. Rates on mortgages and auto loans are set by market forces and do not directly move with the FOMC's decisions.

This was the FOMC's first meeting of the year; the next is scheduled for March 15.

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