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Low Fed rate pushed to late 2014

By Claes Bell · Bankrate.com
Thursday, January 26, 2012
Posted: 8 am ET

The Federal Reserve's Open Market Committee voted to keep the key federal funds rate near zero, where it has been since December 2008. The biggest news is that the current low rate will likely persist through late 2014 rather than the previous projection of mid-2013, according to the FOMC statement:

The Committee decided today to keep the target range for the federal funds rate at zero to 0.25 percent and currently anticipates that economic conditions -- including low rates of resource utilization and a subdued outlook for inflation over the medium run -- are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

The FOMC did opt not to pursue any new quantitative easing, or QE, measures. QE is a strategy to increase the money supply and stimulate the sagging economy by buying securities such as Treasuries and corporate bonds on the open market.

However, the FOMC left open the possibility of future actions should the economy warrant it, saying it "will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate to promote a stronger economic recovery in a context of price stability."

The Fed's wait-and-see approach is in part a reflection of two significant areas of the economy showing gradual improvement -- housing and jobs, says Troy Davig, a senior U.S. economist for Barclays Capital based in New York.

"We've seen nonfarm payroll growth really pick up in December," Davig says. "Job growth looks like it's improving, initial (jobless) claim data (have) really come down sharply, so that means, of course, employers are not laying off as many workers. That's a very positive sign for the labor market."

On the housing side, "it's not been a stunning turnaround or anything, but there are signs that the level of existing home sales is trending up nicely. Inventories in some parts of the country are still very bloated, but in other parts of the country, inventories are becoming more in line with what's considered historically average, so the housing market is showing signs of healing," Davig says.

The FOMC statement acknowledges some of that positive news:

Information received since the FOMC met in December suggests that the economy has been expanding moderately, notwithstanding some slowing in global growth. While indicators point to some further improvement in overall labor market conditions, the unemployment rate remains elevated. Household spending has continued to advance, but growth in business fixed investment has slowed, and the housing sector remains depressed.

Because of that progress, and the strange dynamics of a presidential election year, more quantitative easing is unlikely for the foreseeable future, Davig says.

Federal Reserve building

"They're still in the middle of Operation Twist, and they're going to be doing those operations through the middle of the year," he says.

Operation Twist is an ongoing program that began in October whereby the Fed sells some of its short-term securities and uses the proceeds to buy longer-term Treasuries and mortgage-backed securities.

"That gets you kind of close to the election," Davig says, "and I think the Fed would prefer not to engage in any highly public moves that would be subject to attention in presidential debates. So I think they'll wait until the first of next year, at least."

But Benjamin Friedman, a professor of economics at Harvard University, says the Fed should be careful about getting too complacent.

"Even though the economy is starting to look better going forward, everybody understands that we have a very large amount of unused resources at the moment," Friedman says. He cites a Congressional Budget Office report that finds a 5 percent gap in gross domestic product between what the U.S. is currently producing and what it would be producing without the recession.

He says that while the slightly positive economic news is certainly welcome, the economy will need to grow much faster than it is now to make up the ground lost in the recession.

"The fact that we have favorable indicators that make us more confident than we were two months ago that we really will get 3 percent growth, that still doesn't speak to reducing the gap between where we are and where we ought to be," Friedman says.

Friedman says the European debt crisis also presents a danger to the U.S. economy that the Fed is likely keeping a close eye on.

Indeed, the FOMC statement reflects this concern: "Strains in global financial markets continue to pose significant downside risks to the economic outlook."

In the event that problems in Europe worsen, the FOMC may make moves beyond its current policy of lending dollars to European central banks.

"The situation is very precarious," Friedman says. "If Europe has an ordinary garden-variety recession, that's of course not good for the American economy. We ship some volume of our exports to Europe, but it's not terrible. By contrast, if Europe has a banking crisis, it's hard to see how we're going to have even 3 percent growth."

Federal funds target rate

The federal funds target rate from Sept. 27, 1982 though Jan. 23, 2012.

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