Surprise, surprise. As expected, the Federal Reserve on Tuesday held short-term interest rates unchanged at historic lows and maintained that it will keep rates low for an “extended period of time.” The central bank also reiterated its pledge to stop buying mortgage-backed securities at the end of this month. However, the Fed did upgrade its assessment of the economy.
Though the Fed’s decision was virtually a non-event, the S&P 500 managed to rally to a 17-month high by the end of Tuesday’s session. Doug Roberts, founder and chief investment strategist of ChannelCapitalResearch.com and author of Follow the Fed to Investment Success: The Effortless Strategy for Beating Wall Street, says Fed Chairman Ben Bernanke wants policy statements to be non-events.
“It’s ... a brief statement, and he basically uses speeches either before or after to explain what he wants to do,” Roberts said in an interview. “He uses that as a trial balloon so as to avoid a sudden market shift into overdrive, which puts the Fed into a reactive mode.”
Andrew Busch, global foreign currency and public policy strategist for BMO Capital Markets, says Tuesday’s statement underscores that the Fed is in no hurry to indicate its readiness to raise interest rates or withdraw the massive amount of stimulus in the system. “There were some positives in the statement that [were] slightly different than before, but not materially so,” Busch said in an interview. “I think the Fed knows that job growth is coming to the U.S. It’s just not going to be super-robust ... I expect employment to grow with the release of March's employment data at the beginning of April. The clock for the Fed starts then.”
Still, there is a large amount of labor slack, core inflation is a non-issue, and bank lending remains subdued. “Indicators you can examine to see if the economy is going to generate problems as far as inflation are just not there yet,” Busch said.
The road ahead for the Fed
Experts are mixed as to when the Fed will act to change its policy-statement language or raise rates. Busch says he thinks we'll see a change in lingo at the end of the second quarter and a rate increase before the year is up. He says he expects the economy to come back faster and stronger than most anticipate.
What’s interesting, though -- as Busch points out -- is that overnight indexed swap spreads are not pricing in a rate hike for 12 months. This speaks to Roberts’ belief that we will not see a change in language for some time, or a rate hike before year’s end. “The Fed has a dual mandate: price stability and employment,” Roberts said. “You have to take into account 10% unemployment, which is expected to stay at that level. Until that gets down, absent other pressures, rates are going to stay low for a while.”
There is risk for the Fed, though, in the form of the implications for its policy actions down the road. The dissenting member of the Fed’s policy action, Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, described this risk Tuesday, pointing out that decisions that are made today will impact the economy and inflation in the future. “He’s trying to figure out whether the Fed’s easy policy could potentially cause problems down the road,” Busch said. “The best example of that is what happened with the easing in 2003-2004. It showed up in 2008 when we had $150-a-barrel oil in the middle of a recession.”
When material changes occur, don’t expect them through the monthly policy statement. Roberts says they will will be relayed in speeches and floated multiple times before actually being implemented.
Even so, Busch says he thinks that when it’s time to raise rates and withdraw the monetary stimulus, the Fed will have a difficult time communicating its intentions to the market. He points to the raising of the discount rate earlier this year as an example: “They have to be extremely careful with each little tweak they put out there, each withdrawal of stimulus.”
What it means for investing
In the meantime, the biggest beneficiaries of low rates continue to be the banks -- whether community banks like Hudson City Bancorp
But Roberts warns, “What the government giveth, the government taketh away.” Banks did receive bailouts, but some, such as Citigroup
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