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Wednesday, January 27, 2010

FOMC rate unchanged

The Federal Open Market Committee left the interest rate unchanged - at 0.25%. That was more than expected. What was slightly more unexpected from the broad market was the more upbeat expectations of the FOMC. Part of the real words used in the statement were

"Information received since the Federal Open Market Committee met in December suggests that economic activity has continued to strengthen and that the deterioration in the labor market is abating. Household spending is expanding at a moderate rate but remains constrained by a weak labor market, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software appears to be picking up, but investment in structures is still contracting and employers remain reluctant to add to payrolls. Firms have brought inventory stocks into better alignment with sales. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability."

These words are much more upbeat than anything in the last several years. Still there is a caution expressed and the committee clearly prefers to leave the target rate unchanged while the US economy becomes more stable.

With so much unemployment and lesser material costs it is not surprisingly they don't see a high inflation in the near future - "with longer-term inflation expectations stable, inflation is likely to be subdued for some time".

With that in mind the FOMC states the economic conditions "are likely to warrant exceptionally low levels of the federal funds rate for an extended period". An interesting thing to notice is that there was one voter against the policy - "Thomas M. Hoenig, who believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted". This in fact in sync with the positive tune of the statement and could be pointing that the change in the FED target rate is getting closer.

Still the FOMC main purpose seem to be to ensure the overall recovery from the recession and lifting the target rate will be done after they are sure the improvement won't be damaged by the higher rate.

As the current crisis is caused mostly by excessive lending and risky operations the statement that "...While bank lending continues to contract, financial market conditions remain supportive of economic growth." is maybe one of the most important.

What could be expected in the next several months?

An optimistic view is that the lower rates will continue to be present and as the trust between financial institutions is regained they will start lending more easily to each other. After that such a low target rate won't be needed anymore. In the mean time the unemployment could gravitate around the current levels but the business could start to produce again. Supported not on the last place by the stabilized banks. Only after the companies start to gain some power the unemployment will start to fall as there will be more workers needed again.

The expanding long Eurodollars positions of the Non-commercial players on the futures market support the view about more easy and cheap access to dollars in the next 3 months. These players basicaly happen to be the ones that lend the dollars.

The whole FOMC statement as presented on Marketwatch.

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