US Fed Policy Rate Will Stay in Its Current Range for "an Extended Period"

Location: Toronto
Author: RBC Financial Group Economics Department
Date: Wednesday, March 16, 2011

Once again, the Fed maintained the fed funds target in the range of 0% to 0.25% and reaffirmed the commitment to buy the entire $600 billion in longer-term Treasury securities by the end of the second quarter of 2011 and reinvest principal payments as the securities on the balance sheet mature. The Fed also reiterated that the low level of interest rates is likely to be maintained for "an extended period." While the punch line stayed the same, the tone of the statement indicated that policymakers view economic conditions as having improved.

Importantly, the Fed upgraded its assessment of the labour market, which was characterized as "improving gradually." In past statements, the Fed has said that the pace of growth has been "insufficient to bring about a significant improvement in labour market conditions" meaning that the scales have tipped marginally toward the unemployment rate moving closer to the Fed's mandate of full employment. The statement also points out that the current unemployment rate "remains elevated." Unlike its previous statements, the Fed no longer added that it views employers as "reluctant to add to payrolls."

Both consumer spending and business investment in software and equipment "continues to expand." The real estate markets, however, remain under pressure with residential housing still "depressed" and non-residential investment "still weak."

On inflation, the Fed noted that increasing commodity prices will exert "transitory" upward pressure on prices and that to date, longer-term inflation expectations "remained stable." The statement also highlighted that underlying price pressures have been "subdued" and that they are monitoring both inflation and inflation expectations.

The economic news has been more upbeat during the past six weeks, and this sentiment was echoed in the tone of today's Fed statement. Policymakers still remain reticent to extrapolate the improvement in the economy into a view that the current accommodative stance of monetary policy needs to be altered given that the unemployment rate is still high and underlying inflation "somewhat low." Having said that, the unemployment rate unexpectedly edged down to 8.9% in February along with a solid gain in payroll employment although admittedly the unemployment rate remains historically high. This elevated rate combined with the low level of core inflation (the February report coming out later this week is expected to show the annual increase held steady at a low 1.0%) argues for the Fed to stay the course and keep applying stimulus to the economy for now. The Fed made no changes to its bond-buying program (QE2) of $600 billion by the end of the second quarter of 2011. The Fed will need time to unwind the non-traditional measures put in place to help the economy, thereby making the timing of the first hike in the Federal Funds rate still a ways off from now. We look for the first increase in the Funds target to come in the second quarter of 2012.

Information contained in this report has been prepared by the Economics Department of RBC Financial Group based on information obtained from sources considered to be reliable. While every effort has been made to ensure accuracy and completeness, RBC Financial Group makes no such representation or warranty, express or implied. This report is for information purposes only and does not constitute an offer to sell or a solicitation to buy securities.

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