Fed Expected to Keep 'Extended Period' Low Rate Vow

Friday, 12 Mar 2010 03:52 PM

 

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Lingering U.S. labor market weakness and nagging doubts about the solidity of the economic recovery are expected to keep the Federal Reserve committed to holding borrowing costs very low for a long time at a monetary policy meeting next week.

The Fed — the U.S. central bank — is widely expected to hold benchmark U.S. rates near zero and reiterate that conditions warrant keeping them "exceptionally low" for an "extended period."

The Fed will likely signal that its purchases of long-term securities will end as scheduled at the end of the month. However, it may leave open the possibility they could resume if the recovery falters.

In a sign financial market stability is more assured, the March 16th meeting is the Fed's first one-day scheduled policy conclave since Sept. 16, 2008. The Fed moved to all two-day meetings when the financial crisis intensified.

Below are some possible outcomes of the meeting.

Maintain Extended Period Vow, Signal Asset Purchase Program Ending, But Leave Open Possibility Buying Could Resume:

Most Fed officials have emphasized that high unemployment and tame inflation warrant a continued promise to hold rates very low for a long time.

Some at the Fed believe conditions have improved sufficiently to lift the language, but they are in the minority on the policy-setting Federal Open Market Committee.

The economy grew by a robust 5.9 percent annual rate in the last three months of 2009, but much of the growth reflected government stimulus and a slower pace of inventory draw-downs.

Analysts expect the expansion to ease in months ahead, and the Fed wants to be sure not to extinguish the fragile recovery.

The Fed is expected to say that its purchases of around $1.7 trillion of assets will end as planned March 31. However, in light of the modest pace of recovery, it may well leave the door to further buying unlocked, saying it remains ready to modify plans if necessary to support stability and growth.

• Probability: High.

• Market Impact: Moderate. Firmer stocks, weaker bonds, dollar steady.

Maintain Extended Period Vow, Indicate Greater Anxiety About Pace of Recovery:

Despite some upbeat economic data, some analysts see lagging home sales and construction and a slide in consumer sentiment as pointing to risks the recovery is tottering.

Chicago Federal Reserve Bank President Charles Evans said this week that labor markets may be worse off than even gloomy headline data suggest in light of the unusually long periods many would-be workers have been unemployed.

Other policy-makers have said debt worries in Europe add risks to the U.S. outlook.

The Fed could nod to these headwinds, emphasizing it is in no rush to move to the "out" door, and that while it is letting its asset purchase programs end, it will continue to evaluate whether to buy more.

• Probability: Moderate to Low.

• Market Impact: Marginally negative for stocks, bonds firm, dollar slips.

Drop Extended Period Vow, Signal Purchases Over Without Mentioning Prospects for More Buying:

Some pressure is building within the committee to temper the extended period language by substituting something vaguer like "some time." Such a change would signal interest rate increases are not far off.

Kansas City Fed President Thomas Hoenig dissented against the last reaffirmation of the pledge in January, saying conditions had improved sufficiently to warrant dropping the language from the Fed's policy statement to give the central bank greater flexibility.

Hoenig and some others also worry that the Fed's asset purchases have pumped so much money into the economy that inflation is a risk, and some advocate active sales of assets early on, rather than sitting back and waiting for the Fed's balance sheet to become smaller as securities mature or are prepaid.

Most observers do not expect the Fed to drop the extended period language given unemployment is at 9.7 percent and employers continue to cut jobs.

However, if reports on retail sales, consumer sentiment, and industrial production in coming days prove surprisingly robust, that could put the Fed on notice the recovery is gaining steam.

• Probability: Very Low. After the greatest financial upheaval in nearly a century, the Fed has taken pains to not roil markets with unexpected moves.

• Market Impact: Stocks could gain if the move is seen as a positive for the outlook for growth and employment, or falter out of fears of higher rates. Interest rates would jump across the spectrum. The dollar would gain.

© 2014 Thomson/Reuters. All rights reserved.

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