FOMC policy statement – status quo, but cautiously bullish

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This post is a guest contribution by Asha Bangalore, economist of The Northern Trust  Company.

The FOMC left the federal funds rate band 0%-0.25% intact, no surprises here. Several modifications to the March statement were necessary in light of recent economic reports pointing to improving economic conditions. Here are the changes from the March 16, 2010 meeting:

Fed funds rate: In today’s statement, the much cited phrase “warrant exceptionally low levels of the federal funds rate for an extended period” was left untouched.

Dissent – President Hoenig of the Federal Reserve Bank of Kansas has now dissented at three consecutive meetings. In Hoenig’s opinion, the exceptionally low level of the federal funds rate is no longer necessary and it has the potential to build up “financial imbalances and increase risks to longer-run macroeconomic and financial stability.”

Economy: In its March statement, economic activity was seen to be strengthening. Today, the Fed retained this view. The labor market is now seen as “improving” compared with the March portrayal that it is “stabilizing”. Restraints from high unemployment, modest income growth, lower housing wealth, and tight credit continue to be pertinent factors holding back the pace of consumer spending. In today’s missive, consumer spending is deemed to have “picked up” vs. “expanding at a moderate rate” in the March statement. Although housing starts are at a depressed level, they have “edged up,” which is more bullish than the March statement when housing starts were seen as flat.

Inflation: The language regarding inflation was left intact vs. the March statement.  Inflation is predicted to be subdued for some time.

Fed’s balance sheet: The Fed’s portfolio includes $1.25 trillion agency mortgage-backed securities, an asset acquired to stabilize the housing market and hold down mortgage rates. The widespread speculation that today’s announcement would include indications of the Fed’s plan to liquidate these holdings proved incorrect. Undoubtedly, the meeting would have included discussions about the balance sheet of the Fed. In our opinion, the outright sale of mortgage-backed securities is many months ahead and will be tied to developments in the housing market. In the early stages of tightening monetary policy, reverse repos, term deposits and higher interest rates on excess reserves will be favored over sale of mortgage-backed securities.

Further insight on the Fed’s decision is also provided in the video clip below, featuring Ken Volpert, a Vanguard principal, and Bill Gross, co-CIO & founder of Pimco.

Sources: Northern Trust – Daily Global Commentary, April 29, 2010 and CNBC, April 28, 2010.

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