Steady as she goes: Fed maintains its course
September 18, 2013
The U.S. stock market soared on news that the Federal Reserve would continue its package of stimulative measures designed to keep interest rates low. It won't be until the applause dies down that investors start to worry about what happens next.
The latest meeting of the Federal Open Market Committee (FOMC) concluded with a decision to continue stimulative measures that include keeping the fed funds rate near zero and making monthly purchases of mortgage-backed and Treasury securities totaling $85 billion in order to influence long-term interest rates lower. There had been widespread speculation that the Fed would soon begin tapering off those purchases, but without the Fed's economic targets being met, no timetable for that tapering has been set.
Key Fed targets
The specific economic targets the Fed has mentioned are getting unemployment below 6.5 percent while keeping inflation below 2 percent. Per the latest figures from the Bureau of Labor Statistics, unemployment is at 7.3 percent, while inflation is at 1.5 percent.
Each of these targets is fundamentally different from the other. The Fed's stimulative measures are designed to get the economy moving again, which means putting more people back to work. Thus, lowering unemployment can be seen as the Fed's primary goal at the moment. Meanwhile, it is important to keep an eye on inflation, because if that started perking up, it could force the Fed to rethink its approach. So far though, inflation has remained quiet.
Inflation remains quiet … too quiet?
While low inflation gives the Fed a freer hand to pursue stimulative policies, there is some concern about it. In the last two FOMC statements, the Fed has noted that inflation below the 2 percent mark could pose risks to the country's economic performance.
These cautionary words recognize two economic realities. One is that while moderate inflation is good, abnormally low inflation is a sign that economic demand is weak. In turn, low inflation creates little urgency to buy now, which further contributes to weak demands.
Beyond what they can do with their monetary tools, Ben Bernanke and the FOMC seem to be getting some mileage out of the psychological weapons at their disposal. Bernanke has stressed the importance of transparency, by which he means signaling in advance when a change in policy may be coming. Just the talk of tapering off Fed asset purchases earlier this year sent bond yields and mortgage rates higher, which has the effect of easing into the tapering when it does occur. In turn, after all the speculation about tapering, the markets soared today simply because the Fed isn't cutting back on asset purchases yet, which means the Fed got a market bump without having to deploy any new policies.
Unfortunately, savings account rates and other bank rates have been left behind by the rise in other interest rates, but if the Fed succeeds in boosting economic growth, deposit rates will ultimately be invited to the party as well.