US FOMC: Fed Funds Target Steady at 0% to 0.25%; Monthly Purchase Program Trimmed Back $10 Billion to $65 Billion


 
Author: RBC Financial Group Economics Department
Location: Toronto
Date: 2014-01-30

At Ben Bernanke’s last meeting as Chairman, Federal Open Market Committee (FOMC) members agreed to trim the size of the monthly securities purchase program to $30 billion of agency mortgage-backed securities (MBS) and $35 billion longer-term Treasury bonds per month from $35 billion and $40 billion, respectively. This was the second reduction in the size of the purchase program. No change was made to the fed funds target band of 0.0% to 0.25%. In the statement, the Fed said that the economy had improved and reiterated that the risks to the outlook for the economy and labour market have “become more nearly balanced.”

The Fed announced it will purchase $30 billion of MBS and $35 billion of US Treasury bonds each month, which met expectations and was in line with the previous statement that the program would be reduced in “measured steps.” The economy’s stronger performance in recent quarters and solid increase in employment in 2013 supported the decision with additional tapering moves likely to come in the months ahead as labour market conditions continue to improve and inflation grinds toward the long-term objective of 2.0%. With that said, the Fed remains in data-watch mode, and should the economy fail to meet expectations, further reductions in the securities purchase program could be pushed into the future.

As expected, the current target for the federal funds rate of 0.0% to 0.25% was maintained, and the Fed repeated that this range 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. Given the Fed’s initiative to improve its communication, the statement repeated that policymakers anticipate that highly accommodative policy will still be in place “for a considerable time after the asset purchase program ends and the economic recovery strengthens.” Furthermore, if the inflation rate remains below the 2% goal, then the FOMC would deem it appropriate to keep the funds target at its current level “well past the time” the unemployment rate has fallen below the 6.5% threshold.

Today’s statement was more upbeat with the Fed acknowledging that the economy had picked up its pace in recent quarters and that on balance labour market conditions continued to improve. We expect this sentiment will be substantiated by tomorrow’s report on fourth-quarter real 2013 gross domestic product (GDP), which is forecasted to show a 3.3% annualized gain. The US economy likely grew at an average pace of 3.7% in the final six months of 2013. Looking to 2014, we expect the persistence of easy monetary policy and a lessening in fiscal restraint will result in the economy posting a 2.9% gain, with the labour market expected to show another decent year of growth and the unemployment rate slowly falling toward the Fed’s 6.5% target.

Against this backdrop, we expect the Fed will persist in tapering the amount of securities that it purchases on a monthly basis although we anticipate that policymakers will be content to follow a path of reducing the program in $10 billion increments at each of its upcoming meetings. Unlike the labour market, inflation pressures continue to run well below the Fed’s target of 2.0%. The headline consumer price index (CPI) rate averaged just 1.5% last year, the Fed’s preferred measure, the personal consumption expenditure (PCE) deflator, increased at a 1.1% pace, and the core PCE deflator increased at 1.2% on average from January to November 2013.

Given the significant amount of excess capacity in the economy, it is likely that the inflation rate will remain below the Fed’s target until late 2015; at which time, policymakers will begin the process of tightening monetary policy by raising the fed funds target band. With that said, the improvement in the economy is recent quarters will keep the Fed on course to implement its slow policy stimulus reduction plan in the year ahead.

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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