When it comes> to monetary policy, no news is good news at least that s what the markets seemed to say Tuesday.
Stocks rose following the Fed s announcement that the benchmark interest rate would stay low for an extended period. As expected, that key phrase remained unchanged from previous statements, indicating that the central bank is not yet ready to raise the federal funds rate from its record low of between 0.00% and 0.25%.
Still, the statement included some useful information for investors. Although large portions of the text were unchanged from the previous statement in January, there were a couple small but significant changes in the description of the current economic situation that could speak to the rate of the recovery. And the statement offered more detailed reasoning behind the Federal Open Market Committee s sole dissenting voice.
Here a few key points about the announcement:
What has changed in this statement?
Almost nothing. Fed governors reiterated their belief that inflation is likely to be subdued for some time and kept the federal funds rate at an exceptionally low level. The Fed also affirmed the previously announced timing of the unwinding of extraordinary programs undertaken during the financial crisis, including the purchase of mortgage-backed securities, which should be completed by the end of this month.
The Fed again highlighted that even though financial market conditions are improving, lending continues to contract. What the case would be to raise rates when credit is contracting it s a little hard to square that circle, says Keith Hembre, the chief economist at First American Funds. Because low rates are an incentive to borrow, the Fed is likely to keep rates low until lending picks up, Hembre says.
Does the Fed see the inflation outlook changing?
No the statement s description of the inflation outlook is identical to January s statement, saying that inflation is likely to be subdued for some time. The Fed has a dual mandate to promote price stability and full employment. With inflation still in check, the bank can keep monetary policy loose to stimulate economic growth.
Inflation concerns may be muted now, but money is still entering the system faster than it is exiting in the form of lending, says Kevin Mahn, the chief investment officer of Hennion & Walsh. Inflation is here, it just hasn t reared its ugly head yet in terms of prices and wages, Mahn says. A failure to deal with inflationary pressures now could stall economic growth down the road, he says.
What is the Fed saying about the pace of economic recovery?
The language of today s statement suggests the Fed sees continued improvement in the economy. In January, the Fed stated that deterioration in the labor market [was] abating, and today s statement says the labor market is stabilizing. That tweak likely reflects the fact that job losses have slowed, Mahn says.
The Fed's statement also indicates a stronger view of the prospects for business investment, with the central bank saying that business spending has risen significantly. A pickup in business investment will be a crucial factor in creating sustainable economic growth and real improvement in the job market, Brian Sozzi, an analyst at Wall Street Strategies, wrote in a report this afternoon.
Has the timeline for a change in the federal funds rate changed?
Analysts say Tuesday's statement doesn t indicate any change in the timing of a future rate hike. As he did in January, Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, voted against the policy action. This time, the statement expanded on his objection to the crucial extended period language, saying that he is concerned that it could lead to the creation of asset bubbles.
The dissent wasn t necessarily stronger than January s, just more fully articulated, Hembre says. (The single sentence was 53 words long, up from 39 words in January.)
Still, however Hoenig s dissent is expressed, the key point is that no other governors joined him, says Doug Roberts, the chief investment officer of Channel Capital Research and the author of Follow the Fed to Investment Success. In this case, it s quantity over quality, he says. Even though Hoenig may be more specific, there s still only one of him.
So for the majority of the FOMC, the length of that extended period still remains an open question. Many observers say a policy change will come sometime in the second half of the year, but raising rates will be politically difficult in an election year if the job market doesn t improve. By keeping rates so low for so long, the Fed may find it has to raise them more quickly than it typically does when employment finally does pick up, Mahn says.