Fed Leaves Rates Steady as 'Significant Risks' Linger

Tuesday, 13 Dec 2011 02:30 PM

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The Federal Reserve on Tuesday held its key benchmark lending target, the federal-funds rate, at 0.25 percent.

The Federal Reserve Open Market Committee said in a statement that while the economy may be growing, and while inflation remains stable, "significant downside risks" do remain.

"While indicators point to some improvement in overall labor market conditions, the unemployment rate remains elevated," the Fed said in a statement. "Household spending has continued to advance, but business fixed investment appears to be increasing less rapidly and the housing sector remains depressed. Inflation has moderated since earlier in the year, and longer-term inflation expectations have remained stable," the Fed said in the statement.
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Events outside of the United States continue to pose threats to price stability and unemployment rates.

"Strains in global financial markets continue to pose significant downside risks to the economic outlook," the statement said.

"The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee’s dual mandate. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations."

While the U.S. economy improves, the European debt crisis and swings in commodity prices from global events such as rising demand or natural disasters have threatened the fragile recovery here.

The Fed added it was sticking with its views that interest rates will stay low through 2013 and that it would continue to take measures to extend the average maturity of its holdings to ensure long-term interest rates in the market follow suit.

The latter measure, often referred to as Operation Twist, sees the Fed selling its short-term Treasury holdings and buying longer-term Treasury instruments in the market in such a way to keep rates on loans such as mortgages low.

While the Fed did not mention rolling out further extraordinary monetary policy tools directly, language suggesting "strains" on global markets or inflation settling over coming quarters "at levels at or below those consistent" with the committee’s mandate to keep prices stable could mean markets should not rule out a third round of quantitative easing next year.

Under quantitative easing, the Federal Reserve buys assets from banks, such as mortgage-backed securities or Treasurys.

The idea is that such a move pumps liquidity into the financial system to steer the economy away from deflation, a crippling cycle of falling prices and shrinking economic output, and closer towards stock-market gains and eventually, hiring.

The Fed rolled a first round, known widely as QE1, which saw the central bank snap up $1.7 trillion in mortgage-backed securities from banks, while a second round, or QE2, saw the Fed buy $600 billion in Treasury bonds.

The Federal Reserve said Tuesday that Charles Evans, head of the Fed's Chicago branch, went against the committee because he opted for fresh easing now.

charlesveansfed200fed.jpg
Charles Evans
(Fed Reserve file photo)
Quantitative easing draws praise from supporters, who say it keeps the economy from falling into deflation and pumps up stocks prices, while critics charge it threatens to push up inflation pressures, cheapens the dollar and arguably doesn't resuscitate the economy enough to offset the risks that come with it.

Prior to today's decision, many experts had already been expecting the Federal Open Market Committee to put off making the decision of whether or not to roll out QE3.

"Recent economic data takes away some of the urgency for the need to engage in a new round of quantitative easing,” Michael Feroli, a former Fed economist who is now chief U.S. economist at JPMorgan Chase & Co. in New York, told Bloomberg prior to the Fed's announcement.

The Federal Open Market Committee "can say, 'Let’s wait and see if this is going to build on itself.'"

Other have said they don't want to see it all, pointing out in the end, it just adds to the Fed's balance sheet, thus keeping the country mired in debt and constantly under threat of rising inflation rates.

On top of that, critics say, Federal Reserve officials tend to make such decisions based on the behavior of core inflations rates, which are stripped of the effect of volatile food and energy prices.

Officially, the consumer price index rose 3.5 percent on year in October, according to the Bureau of Labor Statistics, although inflation stripped of volatile food and energy prices came to an annualized increase of 2.1 percent.

Take that with a grain of salt, says noted commodities investor Jim Rogers.

"Anybody who buys, who goes shopping knows that prices are going up. Buy food, education, insurance, just about everything that we buy, prices are going higher and the government tells us there's no inflation," Rogers recently told Moneynews.

"Some independent measures say it's over 6 percent already ... it's going to go much higher because they keep printing money, and as long as they keep printing money, it's going to get worse. So prepare yourself for much higher inflation."

The U.S. economy grew by 2.0 percent in the third quarter of this year, and although that's well above recessionary thresholds, it's not exactly robust and not near enough bring unemployment levels down from their current rates of 8.6 percent to pre-recession levels of below 5 percent.

Furthermore, unemployment rates have been falling not due to any major surges in hiring but rather, due to a growing number of people quitting looking for work, thus taking themselves out of the labor pool and lower the percentage of those that can used to tally unemployment rates.

Economists have said they'll keep a close eye on Europe, as signs the crisis is spreading can hamper U.S. recovery.

"Our global growth baseline now includes a sharp slowdown in China, a recession in Europe and the risk of a mild downturn in the U.S. We forecast global growth of just 2.8 percent in 2012, moderating further to 2.7 percent in 2013," according to the research firm, headed by New York University economist Nouriel Roubini.

That puts the chance of a U.S. recession at 50-50, the firm said earlier on Monday.

Compared with the eurozone, "the U.S. looks more resilient (even the U.S. of 2008-09 would look more resilient…), but there are extensive downside risks to our baseline of 1.4-1.5 percent growth in 2012-13; thus we still see a 50 percent chance of an outright recession in the next year."

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