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Fed Holds Rates, QE in Place as Congress Holds Budget Hostage

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The Federal Reserve’s policymakers decided Wednesday to hold firm on their current interest rate and quantitative easing policy, saying that the U.S. economy is still fragile enough to warrant no changes.

At the same time, Fed Chairman Ben Bernanke signaled that the Fed’s continuing policy serves as an economic counterbalance to Congress’ sequester spending cuts. He also admitted that the Fed was aware of market players’ “reach for yield” as interest rates remain persistently low and that there were “balance sheet risks” associated with the U.S. government carrying heavy amounts of debt on its books.

Saying that the Federal Open Market Committee continues to see downside risks to the economic outlook, the FOMC’s policymakers announced in Wednesday’s release that they would keep the “exceptionally low range” for the federal funds rate in its current target range at 0% to 0.25%. These low rates “will be appropriate at least as long as the unemployment rate remains above 6.5%” and inflation stays no more than half a percentage point above the 2% goal, the Fed said.

In its efforts to prop up the economy by keeping interest rates down, the Fed also will continue to buy agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.

Fed watchers agreed that there were no surprises in Wednesday’s announcement.

“For now, the message continues to be full speed ahead on QE3,” wrote Jim O’Sullivan, chief U.S. economist with High Frequency Economics, Valhalla, N.Y., in an analyst note. “In short, nothing very surprising. The message: the growth data have been a bit better than expected, but much more improvement is needed and there are still downside risks. For now:  no let-up in Fed easing.”

Similarly, Anthony Valeri, market strategist with LPL Financial, said in a phone interview that the overall takeaway “is that Bernanke and the Fed remain very dovish.”

Valeri pointed to the announcement’s mention of more restrictive fiscal policy and said it indicated that Bernanke and his fellow FOMC members remained wary of the economic impact of the congressional budget sequesters. “Just because the economy is getting better does not give the Fed the green light to remove stimulation because fiscal policy is more restrictive. That’s a specific reference to the sequester,” Valeri said.

In a press conference following the FOMC’s announcement, Bernanke stressed that the QE asset purchase program is being conducted on a month-to-month rather than an ongoing basis due to the uncertain nature of hitting targets. However, the FOMC believes the asset purchase program is successfully “putting downward pressure on interest rates, including mortgage rates,” Bernanke said.

Also on Wednesday, the FOMC released projections from its March 19-20 meeting that foresee a lower jobless rate and a rise in GDP between now and 2015. The FOMC projects that unemployment will drop to somewhere between 5.7% and 6.5% by 2015 from its current range of 6.9% to 7.6%, while GDP growth will rise to 2.5% to 3.8% from its current range of 2.0% to 3.0%.

“Labor market conditions have shown signs of improvement in recent months, but the unemployment rate remains elevated,” the Fed said in its announcement. “Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy has become somewhat more restrictive. Inflation has been running somewhat below the committee’s longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices.”

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