When Federal Reserve chairman Ben Bernanke called the recession “very likely over” last week, there was talk about whether his colleagues on the Federal Open Market Committee agreed. In the policy statement issued Wednesday afternoon, it looks clear that they do.
“Economic activity has picked up following its severe downturn,” reads the Fed’s statement in the first paragraph. The FOMC agreed to keep short-term interest rates at exceptionally low levels “for an extended period,” and none of the 10 voters dissented from the expectation that “inflation will remain subdued for some time.”
The Fed noted that financial market conditions have “improved further,” that housing activity has “increased,” and that household spending “seems to be stabilizing”.
However, any talk of recovery was cautious. The policy statement cites concerns for “ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.”
Looking ahead, the Fed expects the economy to “remain weak for a time,” but no specific time frame was mentioned. Meanwhile, the Fed will use a “wide range of tools” to preserve price stability and promote recovery.
While policy remained unchanged, the statement did include one surprise: the Fed said it would “gradually slow the pace” of purchasing mortgage-backed securities and Treasuries “to promote a smooth transition in markets.” So far, about $862 billion of MBS has already been purchased, and the central bank reiterated that it will purchase a total of $1.25 trillion, plus $200 billion in Treasuries. The intervention should be complete by the end of Q1 2010, three months later than original projections.
"The most significant new development was the extension of the Fed’s purchases of agency MBS and agency debt," said Joseph LaVorgna from Deutsche Bank. "The Fed intends to 'phase-out' its support of the mortgage market similar to the fashion in which it is phasing-out Treasury purchases. This will allow the Fed to test the markets, in order to determine if private sector appetite for mortgage origination is sufficient to sustain the nascent housing market recovery."
He added, "If mortgage rates back up significantly between now and the scheduled end-date for purchases, we would not be surprised to see the Fed step in with further support, because a stable housing market is essential to both consumers and lenders at this point in the recovery."
In a related press release, the New York Fed said the three-month extension would allow the central bank to "gradually reduce the average weekly purchase amounts of agency mortgage-backed securities, starting with purchases conducted during the reporting week beginning Thursday, September 24, 2009." Other terms of the program remain unchanged, but this is an important step allowing the Fed to gauge how private investments will hold up as they unwind from their unprecedented involvement in the financial markets.
“The Fed is still a long ways from executing an exit strategy,” said Sal Guatieri from BMO Capital Markets. “Accordingly, bond and equity markets rallied and the U.S. dollar weakened. We still expect overnight rates to remain steady until next summer.”
