US FOMC Left Fed Funds Target and Purchase Program Unchanged

• The Federal Open Market Committee (FOMC) maintained the fed funds target in the 0.0% to 0.25% range, held the size of securities purchase program at $40 billion of agency mortgage-backed securities (MBS) and $45 billion longer-term Treasury purchases per month.

• As to any forward guidance to these purchases, it reiterated the comment that “the Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate” level of policy accommodation as conditions change.

The FOMC met expectations today by making very limited changes to its policy statement and maintaining the size of its security purchase program at $85 billion per month. The statement also reiterated that the current target for the federal funds rate of 0.0% to 0.25% is anticipated to be “appropriate at least as long as the unemployment rate remains above 6.5%,” and the outlook for inflation remains “no more than a half percentage point” above the Committee’s 2% longer-run goal. The breakdown of monthly asset purchases remained unchanged, consisting of $40 billion agency MBS and $45 billion longer-term US Treasuries, and principal payments will continue to be reinvested and aimed at supporting low longer-term interest rates, mortgage rates, and easy financial conditions.

Only Ester George dissented from today’s decision because she remained concerned that “the high level of monetary accommodation increased the risks” of imbalances being created thereby pressuring long-term inflation expectations higher.

The assessment of the state of the economy was little changed from the June statement with output having “expanded at a modest pace”, the labour market showing “further” improvement while the unemployment rate is still “elevated”. Fiscal policy is holding back the pace of economic growth although consumption and business investment are advancing. Housing activity was cited as having strengthened although cautioned that mortgage rates had “risen somewhat”. Inflation, the Fed said, has been below the long-term objective although this has not affected inflation expectations, which are stable. The Fed anticipates that inflation will move to the 2% target in the medium term although acknowledged today that there are risks posed to the economy if the inflation rate holds “persistently below its 2% objective”

As in the June statement, the FOMC left its options open with respect to the asset purchase program reiterating that “the Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate” level of policy accommodation. By doing so, the FOMC is driving home the point that the timing of this program’s withdrawal is contingent on the economy’s performance. In June, the Committee updated its growth projections, which showed a gradual acceleration in real gross domestic product (GDP) growth and the unemployment rate falling to between 7.2% and 7.3% in the final quarter of this year from 7.6% in June. We anticipate that the July labour report, to be released this Friday, will show that the unemployment rate edged down to 7.5% and that non-farm payroll employment increased by 190,000.

In the near term, markets will be focused on the path of the economic data with this Friday’s report providing the most current read on the labour market. Second-quarter 2013 real GDP, reported earlier today, showed that the economy grew at a faster than expected 1.7% annualized pace albeit following a downwardly revised 1.1% rate in the first quarter. Although the report confirmed that the economy grew at a sub-potential pace in both the first and second quarters of 2013, some of this weakness was due to the hefty dose of fiscal restraint. The lightening up of this drag in the second quarter is expected to continue for the remainder of this year and, combined with a firming in consumer and business spending, is projected to support stronger growth starting in the third quarter. As both the pace of output and employment growth pick up, the Fed is likely to reduce the size of its monthly asset purchase program with the most likely timing of this move coming in the fall.

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