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Highlights
The Fed left policy rates unchanged today and only made a modest move on extending Operation Twist. The Fed kept the fed funds target at a range of zero to 0.25 percent. Guidance was left unchanged with policy rates expected to be exceptionally low through 2014. The meeting statement downgraded the status of the economy-notably for the labor market and consumer sector. Again, Richmond Fed President Jeffrey M. Lacker dissented. The vote for the statement was 11-1.
The Fed acknowledged that the economy has slowed.
"Information received since the Federal Open Market Committee met in April suggests that the economy has been expanding moderately this year. However, growth in employment has slowed in recent months, and the unemployment rate remains elevated. Business fixed investment has continued to advance. Household spending appears to be rising at a somewhat slower pace than earlier in the year. Despite some signs of improvement, the housing sector remains depressed."
Nonetheless, the FOMC participants expect modest improvement in the economy in coming quarters, but with the usual risks continuing, notably problems in Europe.
"The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook."
The Fed sees the inflation picture as favorable.
"Inflation has declined, mainly reflecting lower prices of crude oil and gasoline, and longer-term inflation expectations have remained stable."
"The Committee anticipates that inflation over the medium term will run at or below the rate that it judges most consistent with its dual mandate."
The only policy move was to extend the Maturity Extension Program-commonly called Operation Twist. So, instead of getting QE3-which few economists expected, though some traders did-the Fed gave the markets OT2.
"The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less. This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities."
The Fed will continue to keep downward pressure on long-term rates. Specifics were given in a separate release by the New York Fed.
"Specifically, the Desk was directed to purchase Treasury securities with remaining maturities of 6 years to 30 years and to sell or redeem an equal par value of Treasury securities with remaining maturities of approximately 3 years or less. The continuation of the maturity extension program will proceed at the current pace and result in the purchase, as well as the sale and redemption, of about $267 billion in Treasury securities by the end of 2012."
Purchases of Treasury securities for the maturity extension program will be distributed across five sectors using the same approximate weights that have been used in the purchases to date. Sales of Treasury securities will take place in securities maturing between January 2013 and January 2016.
On the news, equities initially dipped moderately but later recovered. The rebound was based on some traders believing on a second read of the FOMC statement that the Fed is laying the groundwork for QE3 by saying the economy is slowing and inflation is low.
The bottom line is that the Fed has essentially run out of options that have impact. Operation Twist 2 was more of a bone being thrown to the markets than having real impact. Nonetheless, monetary policy is still very loose and that point should not be forgotten.
What has not been discussed much is that the Fed does not like to make major policy moves just ahead of presidential elections. Operation Twist 2 extends through December of this year-which, of course, is past the presidential election. Unless there are major problems in the economy before November, the Fed is likely done until December other than possibly trivial tweaking of its special programs.
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