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Fed stays steady on low-rate policy

WASHINGTON (3/17/10)--With the Federal Reserve policymakers staying steady Wednesday on keeping the federal funds interest rate at a record low "for an extended period," credit unions can expect the steep yield curve to go even steeper for the summer months, according to Credit Union National Association Senior Economist Steve Rick.

"For those credit unions with strong loan demand, the steep yield curve should increase net interest margins in 2010 as low-rate, short-term deposits are used to fund longer-term higher-rate loans, " he told News Now. "The higher net interest margins should help credit unions cover loan chargeoffs and National Credit Union Administration assessments and therefore earn their way out of the current financial crisis."

The Federal Open Market Committee's (FOMC) press release Wednesday "did not provide much in the way of describing the Federal Reserve's exit strategy from its current extraordinary loose monetary policy," said Rick. "The FOMC repeated its earlier language that economic conditions 'are likely to warrant exceptionally low levels of the federal funds rate for an extended period of time.'"

He noted the federal funds future market "is currently pricing in a 25 basis-point increase in the fed funds interest rate target in the fourth quarter of this year, with the target reaching 0.75% by March 2011. The fed funds rate is important because it's used as a benchmark for many business and consumer loans," he told News Now.

"The financial markets were hoping for some guidance on when and how the Federal Reserve plans to drain the $1.162 trillion dollars of excess reserves currently sitting on banks' balances sheets. This is up from $0.002 trillion ($2 billion) in the summer of 2008.

"Bond traders are concerned that strengthening economic activity will entice banks to loan out the excess reserves, thereby creating the proverbial 'too many dollars chasing too few goods,' which is one way to describe inflation," Rick said. "If these concerns become more prevalent, inflation expectations and therefore longer term interest rates will rise. "So with the Fed maintaining the target range for the federal funds interest rate at 0 to 1/4 percent, and longer-term interest rates possibly heading up, the yield curve could steepen further through the summer months."

In its press release, noted that "economic activity has continued to strengthen and that the labor market is stabilizing." It pointed out that household spending was stronger, although "constrained by high unemployment, modest income growth, lower housing wealth and tight credit," and noted an increase in business spending. However, housing remained weak.

"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," said the committee's statement.

The committee "continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

The Fed said its purchases of $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt are "nearing completion and the remaining transactions will be executed by the end of this month."

It also noted that its Term Asset-Backed Securities Loan Facility--the only special liquidity facility left of the facilities created to support the market during the banking crisis--is scheduled to close June 30 for loans backed by new-issue commercial mortgage-backed securities and on March 31 for loans backed by all other types of collateral.

With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time, the committee said.

The only dissenter was Thomas M. Hoenig, who for the second consecutive meeting maintained that the exceptionally low levels of the fed funds rate for an extended period was no longer warranted. He said it could lead to a buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.

The committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability, it said.

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