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Fed Policy Means Reduced Margin Compression For CUs
WASHINGTON (8/1/13)--The Federal Open Market Committee (FOMC) announced Wednesday it would stay the course on monetary policy, and that means credit unions will see a slightly steeper yield curve, which should reduce margin compression for them, said a Credit Union National Association senior economist.
 
The FOMC, as the monetary policymaking body of the Federal Reserve, met Tuesday and Wednesday.  It made no change in the targeted funds interest rate and no mention of when it will start winding down its $85 billion a month bond assets purchase quantitative easing (QE3) program and changed its economic-expansion outlook to a "modest" pace from June's "moderate" pace.
 
"Better-than-anticipated economic growth in the second quarter and a July [payroll processer] ADP employment increase that beat expectations were announced hours before the fed policy statement was released," said Mike Schenk, CUNA's vice president of economics and statistics. "In combination, these developments raised the expectation among many observers that the Fed FOMC statement might hint at--if not specifically state--something about the timing of QE3 calibration.
 
"In the end, those expecting more clarity on timing were disappointed," he said. "And those anticipating (based on previous Fed statements) a September pull-back in the Central Bank's bond-buying program likely are rethinking that prospect.   
 
"Fed decision makers did note downside risks to the economy have diminished since last fall, that the economy is growing at a 'modest' pace, and that labor and housing markets continue to strengthen," he said.

"But they further noted that the unemployment rate remains high, fiscal policy is restraining growth and mortgage rates have increased recently. As a consequence--in an effort to 'support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate,'" the committee decided to continue purchasing Treasuries and agency mortgage-backed securities at the current pace," Schenk said.
 
That means "the effect will be to keep longer-term Treasury yields (and hence mortgage interest rates) stable and near current levels, thus helping to support the housing recovery and broader financial conditions," said Schenk, adding that investors' demand for longer-term bonds has been declining recently and pushing up interest rates.
 
"After reaching a low of 1.66% on May 1, the 10-year Treasury interest rate rose by more than a percentage point in little over two months to reach 2.73% by July 5 and subsequently drifted down to the 2.50%-to-2.60% range in the following weeks. The 10-year Treasury interest rate held relatively steady after the Fed's announcement--in the hour and a half after the announcement it inched down from 2.61% to 2.59%," Schenk explained.

So where are long-term interest rates headed?

"We continue to expect the 10-year Treasury interest rate to stay in the 2.3%-to-2.7% range for the near future, settling at about 2.4% by year-end and 2.7% by the end of 2014 as real interest rates rise faster than expected inflation falls," he said.

"The slightly steeper yield curve should reduce margin compression financial institutions have been experiencing over the last several years, but shouldn't negatively affect the housing market recovery in a significant way.  The Fed is fully cognizant of the fact that continued economic recovery is highly dependent on continued improvement in the housing arena."
 
"Importantly--and as expected--the committee reiterated its intention to keep the federal funds target rate in the range of 0% to .25% and re-stated that it anticipates this exceptionally low range will be appropriate until the unemployment rate falls below 6.5%, the one- to two-year inflation outlook is projected to be no more than one-half point above the 2% long-run goal and longer-term inflation expectations remain well-anchored," Schenk noted.

"Given the Fed's current language, it appears that the federal funds rate target will not be lifted until sometime late in 2014 or early in 2015," he added.
 
To access the FOMC's full statement, use the link.
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