Raw Finance

The Federal Open Markets Committee (FOMC) of the Federal Reserve Board has issued the minutes of its Nov. 3-4, 2009, policy meeting in which the committee elected to leave the federal funds rate at a historic low of a range between 0 and .25 percent.  In the minutes, the FOMC members generally agreed that the economic recovery would continue to gather strength over time, but unemployment would remain high and inflation muted over the next couple of years.

The FOMC explained, “Based on this outlook, members decided to maintain the federal funds target range at 0 to 1/4 percent and to continue to state their expectation that economic conditions were likely to warrant exceptionally low rates for an extended period. Low levels of resource utilization, subdued inflation trends, and stable inflation expectations were among the important factors underlying their expectation for monetary policy, and members agreed that policy communications would be enhanced by citing these conditions in the policy statement. Members noted the possibility that some negative side effects might result from the maintenance of very low short-term interest rates for an extended period, including the possibility that such a policy stance could lead to excessive risk-taking in financial markets or an unanchoring of inflation expectations.”

As I have noted in prior posts, the move toward risky assets in search of higher yield has already begun, but even though certain markets are “frothy,” there is little risk yet of another bubble bursting.  However, as the FOMC noted, they will need to pay particular attention to this issue, and I believe it will force the FOMC to raise rates toward the middle of 2010.  This may be sooner than the FOMC would like, but they may need to risk slowing the recovery in favor of protecting it against another market crash.  Maintaining such balance will be a monumental task for the central bank and its counterparts around the globe.

The FOMC also agreed to announce its intention to purchase $1.25 trillion of agency mortgage-backed securities (MBS) by the end of the first quarter of 2010. The FOMC also specified that its agency debt purchases would cumulate to about $175 billion by the end of the first quarter, $25 billion less than the previously announced maximum for these purchases. “Owing to the limited availability of agency debt and concerns that larger purchases could impair market functioning, the Committee’s transactions in these instruments for some time had been on a trajectory that would leave total purchases somewhat below the previously established maximum. Announcing that purchases would total about $175 billion was viewed as providing greater clarity to the public regarding the expected amount of purchases and would not reflect a decision to scale back the degree of policy accommodation. Members also decided to reiterate their intention to gradually slow the pace of the Committee’s agency MBS and agency debt purchases to promote a smooth transition in markets as the announced purchases are completed.”

This is a smart move as government intervention in markets tends to “crowd out” private investment.  What we and the FOMC will be watching closely for is whether private investment returns to these debt markets.  As we have seen with commercial MBS and the Term Asset-Backed Securities Loan Facility (TALF), private money is not keen on jumping into certain markets without government guarantees.