The U.S. Federal Open Market Committee decided today to keep its target for the federal funds rate at 2%.
In its accompanying statement, the FOMC noted the increased strain in financial and labour markets due to a crop in consumer spending.
“Economic growth appears to have slowed recently, partly reflecting a softening of household spending. Tight credit conditions, the ongoing housing contraction, and some slowing in export growth are likely to weigh on economic growth over the next few quarters,” the FOMC said.
“Over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth,” the FOMC said.
The FOMC also noted the run-up in inflation following increases in the prices of oil and other commodities, but said it “expects inflation to moderate later this year and next year, but the inflation outlook remains highly uncertain,” it said.
The FOMC added that “the downside risks to growth and the upside risks to inflation are both of significant concern.”
The Fed disappointed some rate watchers with its decision, but economists generally believe that it made the right call, and they don’t see the Fed rushing to cut in the near term.
Amid very volatile markets, some hoped that the Fed would cut rates by 25, or even 50, basis points today. But it left rates unchanged at 2%, although it did mention the turmoil in the accompanying policy statement.
“Today’s statement provided a measured response to the recent financial market developments only by noting a greater array of downside risks to economic growth,” says RBC Economics Research. “As well, the Fed reiterated their view that ‘over time, the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity, should help to promote moderate economic growth’.” It also reiterated its vigilance against inflation.
The Fed’s move was unanimous, as National Bank Financial notes, “Breaking with his own tradition, Dallas Fed Fisher actually opted to support the FOMC’s decision this time around.”
NBF says that the statement will come as a disappointment to those who were hoping for rate cuts or clear guidance on its future path. “For our part, we think that the Fed did the right thing today by keeping the fed funds unchanged. It has become more obvious in recent days that a rate cut is not the most effective way of dealing with the current market turmoil,” it says. “Indeed, providing liquidity and making sure that the effective fed funds rate remains near its target level is what the Fed ought to do at this point,” it adds noting that the effective fed funds rate traded as high as 7% this morning.
“Obviously, a rate cut could have been a way to convey the message that the Fed was sensitive to the situation. But this would be forgetting the gargantuan efforts already put in place to foster a better functioning of financial market (the Fed did go as far as expanding credit facilities to accept equity and sub-investment debt as collateral). We still believe that the solution to the crisis continues to lie with the non-traditional actions being taken by the Fed and the Treasury,” it concludes. “We still believe that the most likely scenario for the Fed is to keep the fed funds target rate at its current level for the foreseeable future.”
RBC says that the increased comment on the uncertainty in the stressed financial sector means that the Fed “may be more apt to lower the policy rate than they were in August to ensure that the economy gets back to a sustainable growth path in the quarters ahead. Still, today’s statement indicates that this is not a fait accompli and that the Fed is comfortable to run with the current mix of accommodative rate policy and the broad use of liquidity support unless it becomes clear that this policy prescription is insufficient to put the economy on a stronger growth path.”
TD Economics also expects the Fed to remain on hold for the time being, and it is still forecasting an eventual removal of stimulus in the second half of 2009. “But given recent developments, if anything were to disrupt this view, it would likely be a cut and not a hike,” it adds.
“The Fed has made the correct decision,” declares BMO Capital Markets. “The funds rate target at 2% is already very low and the FOMC is mindful of the hindsight criticism of the Greenspan Fed in taking the rate down to 1%, which doubtless contributed to the housing bubble. The central bank continues to add liquidity through open market operations; it doesn’t need a rate cut to do that.”
@page_break@“The Fed is clearly reluctant to cut the funds rate at this point given that there are only 200 basis points left to go. Arguably, current financial strains should be addressed with targeted and customized easing, rather than the broad measure of a fed rate reduction,” BMO adds.
“The problems today are complex and unprecedented. Bernanke and Paulson have correctly decided that these issues require case-by-case action using new tools and facilities. There will be no knee-jerk reactions here; but rest assured the Fed and the Treasury will do whatever it takes to prudently reduce financial instability. At this point, that means allowing the market mechanism to work (which undoubtedly implies more financial firm failures) as well as to facilitate the provision of credit without providing openended government support,” BMO says, adding that this raises the odds that the Bank of Canada will also refrain from cutting rates over the near term.
IE