Federal Reserve Prepared to Use Balance Sheet to Ease Monetary Conditions

With Fed funds already as low as they can go and trading in a range of 0 to ¼ percent, no further action was expected on the interest rate front coming out of today's FOMC meeting. In the event, the central bank reaffirmed these exceptionally low interest rates and reiterated the view that this range could be maintained "for some time."

The issue of purchases of long-term Treasuries re-emerged in the statement and the Fed indicated that it was prepared to undertake purchases if it would be "effective in improving conditions in private credit markets." However, it was of note that Fed President Lacker voted against the policy action announced today as he "preferred to expand the monetary base at this time by purchasing U.S. Treasury securities rather than through targeted credit programs." This suggests that support for outright purchases of Treasuries was building within the FOMC though majority support was still not there yet.

When the Fed first announced the lowering of interest rates to its current range December 16, it emphasized the point that it could ease further via its balance sheet through the expansion of the monetary base. Though today's policy action fell short of announcing the commencement of purchases of Treasuries, the accompanying statement provided updates on the alternative channels already opened to pump liquidity into the system. The key channel is through Fed purchases of mortgage-backed securities (MBS) and agency debt where activity had earlier stalled badly as the willingness of private investors to hold securitized assets fell sharply. The statement indicated the preparedness to expand the quantity and duration of these purchases. The central bank also confirmed that it was poised to start purchasing Term Asset-Backed Securities where activity had dried up for securitized non-mortgage loans similar to what had occurred in the MBS market.

The Fed's comments on the economy were not encouraging, indicating that conditions had weakened further since the committee last met in December. Specific releases cited that highlighted this deterioration included: industrial production, housing starts and employment. The Fed summarized its comments on the economy by stating that it expected a gradual recovery to begin later this year though with the risks solidly stacked on the downside.

RBC Financial Group
http://www.rbc.com

The statements and statistics contained herein have been prepared by the Economics Department of RBC Financial Group based on information from sources considered to be reliable. We make no representation or warranty, express or implied, as to its accuracy or completeness. This report is for the information of investors and business persons and does not constitute an offer to sell or a solicitation to buy securities.