Comerica Economic Weekly

comerica logoThe FOMC voted to extend the average maturity of its balance sheet by purchasing $400 billion of Treasury bonds with remaining maturities of six to 30 years. This will be “sterilized” by the sale of an equal amount of Treasuries with remaining maturities of three years or less. The FOMC’s intent is to put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Fed will also now reinvest principal payments of agency debt and agency MBS into additional agency securities, thus directly working to lower mortgage rates. The Fed will maintain its current policy of rolling over maturing Treasuries. There is no change to Fed funds rate policy. The FOMC maintained their mid-2013 target for the near-zero Fed funds rate. The FOMC’s assessment of U.S. economic conditions was downbeat and downside risks were amplified to “significant.” Inflation is viewed as not being a near-term constraint to monetary policy. The probability of recession before the end of 2012 is now 50 percent. Dysfunctional politics on both sides of the Atlantic are preventing the decisive actions necessary to prevent unsustainable positions from devolving. In Europe, the high probability of a default by Greece, combined with a disorganized and inadequate response to that likelihood, is increasing downside risk to other peripheral euro-zone economies and to the core of Europe itself through exposures in the banking system.   An uncoordinated response to a Greek default increases the likelihood that aggregate demand in the euro-zone will shrink in coming quarters.  In the U.S., election year politics appear likely to fan the flames of political rancor. The ongoing spectacle is unsettling and confusing to households and to businesses, and was a key factor in the collapse of consumer confidence in August. We are near the limit of monetary policy.  Any meaningful stimulus to our current weak economy must also include fiscal measures and must also come within the context of long-term deficit reduction. With just under 14 months to go before the next presidential election, political compromise looks increasingly difficult to achieve. Aggregate demand in the U.S. is vulnerable to further weakness in consumer, business and government spending, and to weak exports to Europe and other countries. With weak demand, and ongoing uncertainty, hiring is likely to remain tentative at best. Housing markets will continue to suffer if job growth is weak. As more residential mortgage foreclosures are processed in  the  face  of weak housing demand, house prices will remain soft, delaying  recovery  from the massive negative wealth effect of the house price collapse that began at the end of 2007.    

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