FOMC Preview: Current Conditions Warrant Low Interest Rates

The Fed is expected to keep the policy rate unchanged at 0-0.25% at the January meeting. While there have signs showing improvement in economic outlook, job markets remained the area the Fed concerned the most. The number of payrolls unexpectedly plunged -85K in December, compared with consensus of no change from November, while the unemployment rate stayed at 10%. The Fed will wait until unemployment rate has dropped substantially before considering rate hikes.

Earlier in the month, the Fed Vice Chairman Donald Kohn said that the central bank's stance of monetary policy depends on 'economic conditions, including resource utilization, inflation and inflation expectations' and the 'judgment as to when to begin initiating steps to withdraw stimulus will depend on the outlook for these variable'.

FOMC statements at previous meetings stated that policymakers anticipated that 'economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period', suggesting the central bank will continue monitoring these conditions in order to judge when to tighten.

At December's meeting minutes, it's stated that most of the Federal Reserve's special liquidity facilities (including the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility) will expire on February 1, 2010. Moreover, agency and MBS purchases program will probably be concluded in March 2010. We believe the Fed will restate these plans at the January meeting.

Also noted last month, reserve-draining tools such as reverse repurchase agreements (RRPs) on a large scale and a term deposit facility (TDF) were being developed and tested. However, these tools won't be ready to use until late 2010.
In December, the Fed also said there were plans to discuss alternative approaches to implementing monetary policy in the longer-run. While these comments were rather bearish, we believe policymakers' purpose was to suppress market speculations on premature exits.