Fed to Markets: We’ll Keep Interest Rates Down; Economy Needs Fiscal Reform

By: Bob Post, VP, CIO

On Tuesday, August 9th the Federal Reserve sent an unexpected message to the markets: We'll keep the fed target low providing certainty to the markets. With investors anticipating a strong central bank reaction to a brutal August, the Fed instead noted the weak economy but said virtually nothing about the markets — no quantitative easing, no yield curve flattening, no Troubled Asset Relief Program or any facsimile thereof. Their statement is as follows:

“Information received since the Federal Open Market Committee met in June indicates that economic growth so far this year has been considerably slower than the Committee had expected. Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up. Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Temporary factors, including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan, appear to account for only some of the recent weakness in economic activity. Inflation picked up earlier in the year, mainly reflecting higher prices for some commodities and imported goods, as well as the supply chain disruptions. More recently, inflation has moderated as prices of energy and some commodities have declined from their earlier peaks. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee now expects a somewhat slower pace of recovery over coming quarters than it did at the time of the previous meeting and anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate. Moreover, downside risks to the economic outlook have increased. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To promote the ongoing economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent. The Committee 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 mid-2013. The Committee also will maintain its existing policy of reinvesting principal payments from its securities holdings. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.”

More recently, in Jackson Hole on August 26th, Bernanke offered no new policies now, but did indicate a fuller discussion will occur at the two-day September FOMC meeting, including discussion of the full range of tools available to them to provide further monetary stimulus. The Chairman also invited Washington to provide fiscal reform by instituting pro-growth policies and reform when Congress re-convenes in September.

Bob Post can be reached at bpost@corporateone.coop or 866/MyCorp1.