June 22, 2011

Fed Leaves Rates Unchanged; No Plans for QE3

FOMC maintains federal funds rate at 0% to 0.25% to aid sluggish recovery

Stocks dropped slightly after the Federal Reserve announced Wednesday that it was making no change to U.S. interest rates. In addition, the Fed’s decision not to introduce a third round of quantitative easing when QE2 ends on June 30 had the market slumping.

In the announcement released by the Federal Open Market Committee (FOMC), the Fed said the economic recovery is continuing at a moderate pace, “though somewhat more slowly than the Committee had expected,” with the labor market showing more weakness than anticipated. “The Committee continues to anticipate that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate for an extended period,” the FOMC said.

As economists had expected, the FOMC maintained the federal funds rate at 0% to 0.25% and expressed no plans for QE3. Quantitative easing increases the money supply by flooding financial institutions with capital in an effort to promote increased lending and liquidity.

In a wide-ranging press conference held after the announcement, Fed Chairman Ben Bernanke (above) held to the FOMC script, but he did elaborate on a number of questions about where the U.S. economy is headed.

In particular, reporters pressed Bernanke on the Fed’s use of the term “extended period," which has accompanied FOMC announcements for months. “We use the term ‘extended period’ not to be intentionally opaque, but because we don’t know how long” the federal funds rate will remain at such depressed levels, Bernanke said.

Future rate policy will depend on how the economy, inflation and unemployment evolve. “If we do get job creation and inflation closer to expected level, we can look at an exit period,” from keeping rates low, he added.

Bernanke predicted that U.S. growth will pick up in 2012 but at a lower pace of growth than the Fed had predicted in April. The Fed expects unemployment to decline near term to a rate of somewhere between 8.6% and 8.9% before heading even lower in 2012.

Looking at the debt crisis in Greece, Bernanke said the Fed is in close contact with European central bankers and talking about how to avert threats to European unity. Domestically, he said, the U.S. deficit crisis cannot be resolved with sudden and severe cuts, as threatened by Congress.

“It’s desirable that we lower the budget deficits over the longer term and it is best not to have sudden fiscal consolidation in the very near term,” he said. “I don’t think that sharp immediate cuts in the deficit would create more jobs.”

After the midafternoon press conference, the Dow Jones industrial average was down 50.06 points, or 0.41%, at 12,138. The Standard & Poor's 500 Index was down 4.59 points, or 0.35%, at 1,2991. The Nasdaq Composite Index was down 8.66 points, or 0.32% percent, at 2,678.

Anthony Karydakis, adjunct professor of economics at the Stern School of Business of New York University and senior economist at Commerzbank, said prior to Bernanke’s press conference that the announcement held no surprises.

“Nobody was expecting any fireworks here. The environment was not conducive to any surprises. There was not much room for them to come up with anything unexpected,” Karydakis said. “They did the sensible thing, which was to acknowledge the obvious, that there has been a slowdown on ground in terms of the recovery, but they attributed that with some confidence to transitory factors—the supply chain disruptions because of the Japan earthquake and the run-up in energy prices.”

The Fed made no mention of further quantitative easing because there is no chance there will be a QE3 unless there’s another catastrophic event such as the 2008 financial crisis, Karydakis asserted.

“Recoveries don’t just roll over and die,” he said. “It’s very hard to derail a recovery in almost the third year of a business cycle. You don’t. You can do some damage to the forward momentum of the recovery if you have some developments of the kind we did, and now Europe may potentially lead to trouble. For the economy to have another recession is not an easy proposition, and by the way, it has never happened. We love to talk about these things, but it has never happened.”

Karydakis was also unsurprised that the announcement did not address recent news of the Greek debt crisis or theMoody’s threat to downgrade the U.S. debt rating.

“Those will be questions for Bernanke later in the press conference,” Karydakis said.

Read Bernanke Press Conference: The Message Was the Medium at AdvisorOne.com.

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