By the Blouin News Business staff

Still plenty of Fed punch to go around

by in U.S..

The facade of the U.S. Federal Reserve building is reflected on wet marble during the early morning hours in Washington.

Quietly flows the punch: Photo Credit: Reuters/Jonathan Ernst

For now the punch bowl that every investor expects to be taken away later this year remains in place. The U.S. Federal Reserve said following its latest two-day policy meeting that it would keep buying $85 billion of assets per month to bolster the economy. There was no hint in its post-meeting statement that a reduction of that pace was imminent.

After its June meeting, Fed chairman Ben Bernanke said the central bank would likely start to taper its bond-buying program later this year, with a view to ending it by the middle of 2014. In the absence of any comments to the contrary (and this time there was no post-statement press conference to massage expectations), that must be assumed still to be the case.

Those who believe that tapering will start in December will see reinforcement for their view in that the Fed’s statement changed the description of economic activity to “modest” from last time’s “moderate,” and warned that low inflation, if it persists, could hold back the recovery. Though the economy grew faster than expected in the second quarter, it still grew at only a 1.7% annual rate, and first quarter GDP was revised down to 1.1% from 1.8%.  Equally, Septemberists will read the statement as the Fed acknowledging a soft patch that it expects to pass, and that it remains comfortable with the economic outlook it laid out in June.

All the future guidance to be found in the statement lay in the direction of reinforcing the idea that a long period of low interest rates lies ahead. The Fed has been hammering the point that a reduction in bond purchases does not entail a tightening of monetary policy. It reiterated, again, that it would hold rates near zero for as long as the unemployment rate remains above 6.5%, provided that the inflation outlook over one to two years is not projected to rise above 2.5%.

From the statement:

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

The fine line now being walked by the Fed is to contain the rise in bond yields. This started in May as investor expectations that the third round of quantitative easing would be wound down took hold; the Fed needs to stem that tide so it doesn’t derail the recovery. Yields peaked in July, with the 10-year Treasury yielding 2.7%. The yield is currently 2.6%. That is not much of a retreat.

Mortgage rates, in particular, are worrying the policy makers. Rates on a 30-year fixed home-purchase loan are now at two-year highs. The risk is that they could choke the housing recovery if they rise much further. Hence the Fed’s message that there will still be plenty of punch available for some time — regardless of the container it comes in (i.e. asset purchases or accommodative monetary policy).