Special Report-Growing bloc of the Fed favor selling assets
Monday, April 26th, 2010The FOMC will begin a two-day policy meeting on Tuesday, April 27th concluding on Wednesday, April 28th. At the March FOMC meeting the Fed kept interest rates unchanged and retained its pledge to keep rates low for an “extended period.” Investors will be looking to the April policy meeting for possible clues to the timing of the Fed’s withdrawal of monetary stimulus and tightening of monetary policy. The key question is will the Fed drop its “extended period” language from its policy statement? If the Fed drops the “extended period” language it would be a signal of shift in Fed policy and set the stage for an eventual tightening of monetary policy and future rate hikes. All of the Fed board members expect one have voted in favor of no change in the Fed’s “extended period” language. The Fed’s Hoenig has been the lone dissenter at the last two policy meetings. Hoenig wants the Fed to drop the extended period language and insert new language that rates will remain low for “some time.” According to Hoenig changing the Feds policy language would give the Fed more flexibility and help to anchor inflation expectations.
Recent US economic data confirms improvement in the US economy and higher inflation. Last week the US reported a sharp improvement in the sale of existing home sales which rose by 6.8% and new home sales rose by almost 27%. In addition, US PPI posted a higher than expected rise reflecting a jump in the price of food and energy. The rise in PPI may make it harder for the Fed to argue that inflationary pressures remain subdued. The core PPI inflation rate rose by just 0.1% which suggests that inflation risks remain small. Last week the US reported that jobless claims declined by 24k. Fed officials are monitoring US employment and inflation as the main determinant of when a shift in policy will be justified. The Fed’s Bullard says that if inflation expectations began to rise, the Fed could discard its pledge to hold interest rates exceptionally low even if unemployment remains high.
In the March FOMC policy statement the Fed noted that the labor market appeared to be stabilizing, that industrial production continued to expand along with consumer spending. According to the FOMC the housing market appears to have flattened out and they noted a sharp increase in spending on equipment and software. The FOMC said that although rising energy prices continue to boost consumer inflation excluding food and energy price pressures remained soft. We expect the Fed’s April policy statement to include an upbeat assessment of the US economic outlook and a commitment to maintaining low yields for an “extended period” until there is a sustainable improvement in the job outlook and durable recovery in the housing market. In February Fed Chairman Bernanke said that employment remains the biggest problem facing the US economy. In April he said that there has yet to be evidence of a sustainable housing recovery and inflation expectations appear stable.
Statements from other Fed officials suggest that the FOMC is beginning to discuss how to react to improvement in the US economy. According to the Fed’s Lockhart weakness in construction and municipal budgets will continue to weigh on the economy and he supports policy to keep interest rates relatively low. The Feds Bullard says the recovery looks strong and when sustainable, the FOMC must look to raise rates. The Fed’s Kohn said the gradual recovery will require the Fed to keep rates low but the Fed can’t wait until employment gets to long-term levels before raising rates.
The Fed may signal a few changes in its April policy statement. One could be a signal that the discount rate will need to rise soon. The Feds Fisher said he would like to get the discount rate spread back to 100 bps. A second could be the announcement that the Fed will soon begin selling assets to reduce its balance sheet. CNBC reported last Friday that a growing bloc of the FOMC wants to begin the sale of assets. The extraordinary measures the Fed took last year buying long-term treasuries and mortgage-backed securities helped to prevent the US economy from falling into depression but it also has increased the amount of cash in the economy which raises the risk of inflation as the economy recovers. The Fed may soon look to start selling assets to reduce its balance sheet. Last week the Fed ended its purchases of mortgage-backed securities. According to CNBC at least six of the Fed’s board members favor selling mortgage assets. The Feds balance sheet at the end of last week totaled $2.320trln with 1.25trln in mortgages.
We expect the Fed’s April policy statement to reaffirm commitment to maintaining exceptionally low yields for an extended period citing continued low inflation and elevated unemployment. Although recent US economic data points to pick up in the US recovery, the employment outlook remains uncertain, housing market recovery uneven and inflationary pressures are subdued. The Fed say’s that policy decisions will be data driven and unemployment is the key data set that the Fed is monitoring. Until the pace of US employment growth is on sustainable path the Fed is expected to err on the side of caution and maintain steady rate policy.  Well anchored US inflation expectations will enable the Federal Reserve to keep interest rates low. The impact of steady Fed rate policy decision for USD should be limited as USD price direction is re-linking with risk appetite. The April policy statement may also include guidance about the timing of Fed asset sales and beginning of the withdrawal of liquidity. The Fed’s Lacker wants to begin selling of assets immediately and said the Fed could keep the “extended period” language while unloading assets. The USD may find support if the Fed announces the start of asset sales.
Written by Easy-Forex
