FOMC Policy Announcement, August Producer Prices, Sept. UI Claims

FOMC Launches QE3, Extends Funds Rate Guidance

•    In today’s FOMC press release, the Federal Reserve announced a new plan for quantitative easing.
•    The FOMC also extended its existing guidance about the near-zero fed funds rate to mid-2015.
•    The FOMC stated that the U.S. economy has been expanding moderately, but unemployment is elevated.
•    Inflation is subdued, although some commodity prices are up. Long-term inflation expectations are stable.
•    Strains in global financial markets continue to pose significant downside risks.
•    “Operation Twist” continues through the end of this year.
•    The Producer Price Index for August jumped by 1.7 percent, boosted by energy and food prices.
•    Initial Claims for Unemployment Insurance gained 15,000 for the week ending Sept. 8; weather is blamed.

Today at the regularly scheduled meeting of the Federal Reserve’s Federal Open Market Committee, the FOMC voted to launch a new program of bond purchases (quantitative easing) and to extend their forward guidance about the fed funds rate. The Fed will purchase additional agency mortgage-backed securities, at a pace of $40 billion per month, beginning tomorrow.  There is no time limit set for these additional purchases. The Fed may continue these purchases until the outlook for the labor market improves substantially, meaning that there is now at least a broad (as opposed to specific) unemployment rate target for QE3. The current program of extending the average maturities of Fed holdings (Operation Twist) will continue through the end of this year. These actions are designed to put downward pressure on longer-term interest rates, support mortgage markets, and make broader financial conditions more accommodative. The FOMC also voted to extend their forward guidance on the near-zero fed funds rate, saying that exceptionally low levels of the fed funds rate are likely warranted through at least mid-2015. The vote on the FOMC action was not unanimous. Voting against today’s policy action was Jeffrey Lacker of the Richmond Fed.

It is important to note that today’s MBS-focused launch of QE3 has no specific end date. It is implied, but not specified in the Fed’s statement, that the program will run at least through the end of this year, and possibly longer. The trigger to end the program will be substantial improvement in the labor market outlook.  If the unemployment rate does not decline substantially by the end of this year, quantitative easing will likely extend into 2013. That the Fed’s so-called reaction function is still undefined gives the Fed plenty of wiggle room to adjust policy down the road.

Separately, the producer price index for finished goods for August came in hotter than expected, increasing by 1.7 percent. The energy index gained 6.4 percent and crude oil and product prices increased. Wholesale food prices also increased in August, gaining 0.9 percent. The core producer price index for finished goods (excluding food and energy) was more sedate, increasing by just 0.2 percent for the month. Today’s move by the Fed into additional quantitative easing has the potential to put further upward pressure on commodity prices. Initial claims for unemployment insurance increased by a noticeable 15,000 for the week ending September 8. According to the Department of Labor, Tropical Storm Isaac was a key factor in that increase, accounting for about 9,000 of the 15,000 claim increase.

Market Reaction: U.S. equity markets rallied with the FOMC announcement. Treasury yields initially rose at long end of the yield curve as equity prices jumped. Crude oil is up to $98.11/barrel. The dollar is down against the euro and the yen.

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