The “Extended Period” Is Extended
- According to today’s FOMC policy announcement, Fed policy will remain unchanged from December 13.
- However, the FOMC extended its zero interest rate policy through late-2014.
- U.S. economic conditions improved moderately through late 2011.
- Inflation has been subdued, and inflation expectations are stable.
- Strains in global financial markets pose significant downside risks.
- “Operation Twist” continues as announced last September.
At its regularly scheduled January two-day meeting, the Federal Open Market Committee (FOMC) held near-term Fed policy unchanged, but extended the “extended period” for zero interest rate policy at least through late 2014. The goal of the Federal Reserve is to reduce interest rate uncertainty. However, this may backfire as economic conditions change over the course of the next two-and-a-half years. Current conditions have recently improved, according to the Federal Reserve, including improvement in overall labor market conditions and household spending. But growth in business fixed investment has slowed, and the housing sector remains depressed. Consumer price inflation has been practically nonexistent in recent months, while longer-term inflation expectations are stable. The FOMC expects only modest economic growth over coming quarters, but does not anticipate a near-term U.S. recession. The unemployment rate is expected to decline only gradually. The committee is very focused on downside risks emanating from global financial markets, meaning Europe, but has not quantified the potential drag to the U.S. economy. “Operation Twist” will continue as announced last September, and is expected to run through this coming June. While no additional quantitative easing (QE) was announced at today’s meeting, the issue remains on the table representing another arrow in the Fed’s quiver that it may use if U.S. economic conditions deteriorate. There was only one dissent in today’s vote, by Jeffrey Lacker, President of the Federal Reserve Bank of Richmond, who would have preferred to omit the description of the time period for the extension of exceptionally low levels for the fed funds rate. The FOMC is also further broadening its communication strategy to include the publication of forecasts of the fed funds rate by FOMC members. This is already generating significant media speculation, but will not move markets in the era of hyper-extended extended periods.
Market Reaction: Equity markets opened with losses, but turned positive with the Fed’s announcement. Treasury yields are down at the long end of the yield curve after the Fed’s announcement. Crude oil is up to $99.86/barrel. The dollar is up against the euro and down against the yen.