Fed holds steady, keeps rates near zero

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Chill out, the Federal Reserve says: The economy is getting weaker, but it’s worsening more slowly.

Fed stands pat


The federal funds rate stays at historic low.

In a statement that seemed designed to placate businesses and consumers, the Federal Reserve said that “the economic outlook has improved modestly” in the last five weeks, although “economic activity is likely to remain weak for a time.”

Bottom line, according to the Fed: “[T]he pace of contraction appears to be somewhat slower.”

The central bank’s rate-setting Federal Open Market Committee kept short-term interest rates near zero percent, and said they will remain there “for an extended period.” That’s what the Fed said last time, and it’s what investors had expected.

Specifically, the Fed said it will keep its target for the federal funds rate in a range between zero percent and 0.25 percent. As a result, the prime rate remains 3.25 percent. That means interest rates will remain unchanged for consumer debt tied to the prime rate, including home equity lines of credit and some credit cards.

The Fed continues to target long-term interest rates, too, “to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets.” To that end, the central bank said it will maintain its previously announced policy of buying up to $1.25 trillion in mortgage-backed securities this year. When the Fed began buying mortgage securities a few weeks ago, rates fell and stayed low, and the central bank wants rates to stay low through the end of the year.

In addition, the Fed says it’s keeping its pledge to buy up to $300 billion worth of long-term Treasury notes by autumn. This action is intended to put a lid on longer-term rates for things such as auto loans and student loans.

Trillion-dollar lasso

Central bankers are buying mortgage-backed securities and long-term Treasury notes because they have run out of options on the short end of the loan spectrum. No more federal funds rate cuts are possible, because the Fed can’t take the federal funds rate into negative territory. So it is using a trillion-dollar-plus lasso to snare longer-term interest rates and yank them down.

It has worked. The Fed announced its plan to target long-term interest rates on March 18. Before that date, the average rate on a 30-year, fixed-rate mortgage was lurking around the 5.4 percent range. Since then, it has averaged 5.19 percent, and many borrowers have been getting home loans well below 5 percent after paying 1 or 2 discount points.

In the past few weeks, Fed officials have been talking in faintly optimistic terms. In a speech last week, the vice chairman of the Fed, Donald Kohn, foreshadowed today’s Fed announcement when he said, “Conditions are falling into place for real GDP to decline at a slower rate in the second quarter and to stabilize later this year.” He continued: “I don’t think it is premature to start to ponder the shape that a recovery — when it occurs — would be likely to take.”

He concluded that “my best guess is that we are in for a relatively gradual recovery, though a very wide range of uncertainty surrounds that outlook.” Today’s Fed policy statement implied the same.