The Fed: A Two-Week Recap

As a result of its recent monetary policies, The Federal Reserve has been a frequent news topic over the past several days. January 25th and February 2nd are two key dates of its recent activity and so will be the focus of this week’s recap. In short, expecting prolonged economic instability, the Fed continues fiddling with the market – as usual.

On January 25th, the Federal Reserve’s monetary policy-making group, the Federal Open Market Committee (FOMC), announced that it will keep short-term interest rates (the federal funds rate [1]) near zero (0-1/4 percent) through late 2014. It cited the slow economic conditions as a reason for the continuation of exceptionally low levels.

The Federal Funds Rate is the overnight interbank lending rate. Decreasing this interest rate in effect decreases the cost of credit, stimulating people and businesses to borrow in hope of expanding the economy. However, changes in this rate also effects returns on certificates of deposit, savings accounts, and money market accounts. So, although The Fed’s decision to maintain low interest for the next few years incentivizes borrowing, it also discourages saving. If your assets are in savings or money markets accounts, you can now expect to earn less interest.

The full context of this release can be viewed here [2].

The FOMC also issued a number of important projections about inflation, unemployment, and economic growth. The annual target rate for inflation is 2%; a rate it believes will foster price stability and moderate long-term interest rates. It projected an unemployment rate range of 8.2% to 8.5% for 2012, which are low expectations for improvement. For economic growth, the projection of change in real GDP is an increasing rate range of 2.2%-2.7%. Both the unemployment rate and economic growth rate ranges are lower than those projected in November of 2011.

These projections can be viewed in table and chart format here [3]; the full text of the release can be read here [4].

On February 2, 2012, Fed Chairman Ben Bernanke testified before the Committee on the Budget in U.S. House of Representatives about the economic outlook. “To achieve economic and financial stability, U.S. fiscal policy must be placed on a sustainable path that ensures that debt relative to national income is at least stable or, preferably, declining over time. Attaining this goal should be a top priority,” said Bernanke, in his prepared, detailed statement. Republican Chairman Paul Ryan, of Wisconsin, criticized The Fed’s 2% inflation target projected the previous week, suggesting that it would actually be willing to tolerate higher inflation. Bernanke defended by saying, “We are not seeking higher inflation, we do not want higher inflation and we’re not tolerating higher inflation.”

Video highlights of his testimony with the added touch of dramatic music can be viewed here [5].
The prepared part of the testimony, titled “The Economic Outlook and the Federal Budget Situation,” can be read here [6].

Perhaps the most relevant and most important decision made by The Fed recently is to keep interest rates near zero percent until the end of 2014. With the average savings account return rate at 0.24 percent, a money market account at 0.22 percent, and a 1-year CD at 0.53 percent, those with assets in such accounts may now seek options with higher returns. As a result, they may pursue other financial opportunities with much higher-risk. This is obviously a difficult evaluation to make, especially if you are a retiree who prefers less risky assets. Extending the policy for cheap money also did not help increase investor’s confidence in the dollar, which may explain the increase in precious metals prices seen the day after of the Fed’s actions. Gold rose 1.57%, silver climbed 1.9% and platinum was up 2.4%. Of course, at the other end of the spectrum, if you have debt or need to borrow, the extension on the low interest rate is good news: you will pay less in interest, assuming the rate is linked to the Fed Fund’s Target Rate. In any case, The Fed continues to manipulate the market by maintaining interest rates at artificially low levels; the same levels since 2008. Whether for good or bad, it affects everyone, and everyone should keep watch.

Citations

[1] http://en.wikipedia.org/wiki/Federal_funds_rate

[2] http://www.federalreserve.gov/newsevents/press/monetary/20120125a.htm

[3] http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20120125.pdf

[4] http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm

[5] http://www.bloomberg.com/video/85607022/

[6] http://www.federalreserve.gov/newsevents/testimony/bernanke20120202a.htm