Thursday, August 13, 2009

Fed Seeing Signs of Improvement

The Federal Reserve released their latest assessment of economic conditions yesterday following a two-day meeting. There are legions of “Fed watchers” who always parse the language of the Fed’s statement following these meetings, looking for clues as to what the future direction of monetary policy is likely to be, since any changes can have significant investment implications. In general, it seems that the Fed is seeing signs of improvement in the economy, saying that “economic activity is leveling out” in the opening sentence of the statement, which was stronger than the June version that read “the pace of economic contraction is slowing.” They also pointed out that “conditions in financial markets have improved further in recent weeks.”

In more normal circumstances, the Fed’s change in the tone might be viewed as a precursor to higher interest rates. But, since this cycle is anything but normal, Chairman Bernanke and the rest of the FOMC members have consistently gone out of their way in the past several statements to reassure markets that interest rate hikes are a long way off by stating that the Fed Funds rate will remain between its current 0% - 0.25% “for an extended period.” They point out that any recovery is still threatened by many risks, including job losses, sluggish income growth, lower housing wealth, and tight credit.

They also commented on their quantitative easing program, where they’ve been printing new money to purchase Treasury, mortgage-backed, and federal agency debt in an attempt to keep market interest rates down. Recently many investors have been focused on this aspect of their policy and whether they were going to continue with it and possibly risk igniting inflation, or begin to wind it down in response to increasing signs of recovery. They basically said that they aren’t going to expand the size of the Treasury purchases that they previously announced, and that future purchases will be somewhat smaller but extended for an additional month through October.

All in all, the Fed seemed to do a good job of reassuring investors that policy will remain accommodative and supportive of still-fragile financial markets, while also laying the groundwork for the eventual removal of some of the unconventional programs they’ve implemented if recent improvements evolve into a more sustained recovery.