Wednesday, January 28, 2009

Instant Analysis of Today’s FOMC Decision

Instant Analysis of Today’s FOMC Decision
by Dr. Scott Anderson, Senior Economist for Wells Fargo & Company

The Fed sees economic fundamentals continuing to deteriorate and credit conditions for households and firms as "extremely" tight. In the December statement they only characterized credit conditions as tight. They still anticipate that economic activity will begin later this year, but see the downside risks out-weighing the upside risks at this point.

The Fed kept the federal funds target rate in its present range of 0 to ¼ of a percentage point, and promised to keep the Fed funds target rate at "exceptionally low levels for some time."

The statement acknowledges that the economy has weakened further since December, citing steeply declining industrial production, housing starts, and employment, as consumers and businesses cut back on spending.

The FOMC added a comment about global prospects, perhaps a nod to the IMF’s substantial downward revision in their global growth forecasts today from 2.2 percent to 0.5 percent in 2009, the worst global growth performance in the post-war period. The FOMC statement says today that "global demand appears to be slowing significantly."

Finally, the Fed doesn’t mention the word deflation in the statement, but did highlight the prospect for inflation to persist below rates that best foster economic growth and price stability in the long-term. That’s central bank code for a period of deflation!

Expect further expansion and utilization of the Fed’s existing credit facilities, as well as the addition of new ones in 2009 as the Fed moves further down the path of "credit easing". The FOMC said it was prepared to purchase longer-term Treasury securities if it could help improve credit conditions in private credit markets. This will be somewhat of a disappointment for the bond market, which was hoping for an actual announcement of the plan today.

I believe there are some members of the FOMC that want to move slowly on the plan to buy long-term Treasuries, since in doing so the Fed is basically "monetizing" the debt, trading government IOUs for Federal Reserve IOUs, that could ultimately be destabilizing for the dollar and U.S. inflation down the road.

Right now, 10-Yr Treasury bond yields are up about 13 basis points from yesterday’s close, though stocks are holding on to substantial gains.

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