FOMC: Going All the Way
Overview: The Federal Open Market Committee (FOMC) took yet another aggressive step at its meeting tonight by committing to purchase up to USD300bn in longer-term Treasury securities over the next six months, concentrated in the 2- to 10-year sector of the nominal Treasury curve. In addition, the Fed will expand its MBS purchase programme by USD750bn to a total of USD1,250bn and increase its purchase of agency debt by up to USD100bn. The Fed also scaled up its interest rate rhetoric stating that the Fed funds rate would be held exceptionally low for an "extended period" compared to "for some time" at the January meeting.
An important announcement to watch in coming days or weeks will concern the details on which assets are included in the expansion of the Fed's Term Asset-Backed securities Loan Facility (TALF). Some media sources report that the TALF programme may become a part of the Treasury's plan to remove toxic assets from banks' balance sheets. While tonight's statement confirms that an expansion of TALF is under way, it remains unclear whether it will go beyond newly issued AAA rated asset-backed securities. The move was more aggressive than either we or markets expected resulting in a significant flattening of the Treasury curve. 10-year Treasury yields dropped by more than 40bp while the 2-year segment moved 16bp lower. Equity markets jumped around 2% on the announcement but fell back in later trading. The USD weakened substantially with EUR/USD breaking through 134.
Details: The Fed remains downbeat on the near-term outlook for the economy but expects the economy subsequently to gradually resume sustainable economic growth. The phrase that "downside risks to that outlook are significant" was omitted, suggesting that the Fed has become somewhat more confident of a recovery late this year. On inflation the statement reiterated that there was a "risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term". While the Fed is clearly worried about the risk of deflation this still suggests that the committee sees a relatively limited risk of a deflationary spiral developing.
The committee "will employ all available tools to promote economic recovery and to preserve price stability" which means taking the next step and purchasing Treasuries. Purchases will be made 2-3 times a week through primary dealers with the first purchase operation scheduled for late next week. More information on the purchase programme for Treasury securities is available on the NY Fed's homepage.
The statement leaves the impression of a continuing bias towards expanding the balance sheet further, but it seems to have become more balanced. The Fed will need to see the effects of measures taken so far before further increasing the balance sheet.
Assessment & Outlook: The Fed has taken yet another aggressive move in an attempt to reduce private sector borrowing rates. Although the size of the Fed's purchases in the Treasury market compared to the amount outstanding is smaller than that of the Bank of England, it sends a strong signal to markets, that the Fed will not accept a surge in Treasury yields as long as the financial system remains under severe stress. In addition, the increase in the MBS purchase programme is large. These purchases have already helped to reduce mortgage rates and will probably tend to reduce them further. This will lend important support to the housing market and US homeowners who can refinance with lower rates. Overall these measures should help to ease financial conditions further. We regard the aggressive response as generally positive for US growth.
Going forward we expect the Federal Reserve to hold rates at close-to-zero for a long time. On a short-tomedium term horizon there remains a possibility of further quantitative easing by expanding the Fed's balance sheet but this is likely to be accomplished by broadening already existing programmes. Rate hikes will not be put back on the agenda before the economy returns to trend and unemployment has peaked.
Current statement:
Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract. Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending. Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. U.S. exports have slumped as a number of major trading partners have also fallen into recession. Although the near-term economic outlook is weak, the Committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.
In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.
In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve's balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of evolving financial and economic developments.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.
Previous statement:
The Federal Open Market Committee decided today to keep its target range for the federal funds rate at 0 to 1/4 percent. The Committee continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.
Information received since the Committee met in December suggests that the economy has weakened further. Industrial production, housing starts, and employment have continued to decline steeply, as consumers and businesses have cut back spending. Furthermore, global demand appears to be slowing significantly. Conditions in some financial markets have improved, in part reflecting government efforts to provide liquidity and strengthen financial institutions; nevertheless, credit conditions for households and firms remain extremely tight. The Committee anticipates that a gradual recovery in economic activity will begin later this year, but the downside risks to that outlook are significant.
In light of the declines in the prices of energy and other commodities in recent months and the prospects for considerable economic slack, the Committee expects that inflation pressures will remain subdued in coming quarters. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.
The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability. The focus of the Committee's policy is to support the functioning of financial markets and stimulate the economy through open market operations and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. The Federal Reserve continues to purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand the quantity of such purchases and the duration of the purchase program as conditions warrant. The Committee also is prepared to purchase longer-term Treasury securities if evolving circumstances indicate that such transactions would be particularly effective in improving conditions in private credit markets. The Federal Reserve will be implementing the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Committee will continue to monitor carefully the size and composition of the Federal Reserve's balance sheet in light of evolving financial market developments and to assess whether expansions of or modifications to lending facilities would serve to further support credit markets and economic activity and help to preserve price stability. mission.
Danske Bank
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