Fed keeps rates, bond-buying steady, good for CUs

WASHINGTON (12/15/10)--Federal Reserve policymakers' announcement Tuesday that it will maintain interest rates on targeted funds and keep its existing quantitative easing (QU2) policy of purchasing $600 billion in bonds is good for credit unions' future net interest margins, according to Steve Rick, senior economist with the Credit Union National Association (CUNA).

"Tuesday's Federal Open Market Committee (FOMC) statement reiterated its desire to use the Federal Reserve's balance sheet to keep downward pressure on interest rates to invigorate a moderate recovery," said Rick, after the meeting. The committee's "recently announced QE2 policy, whereby the Fed purchases $600 billion of Treasury securities to drive interest rates lower and drive investors into riskier assets, seems to be working quite well. Maybe too well," he said.

"Recent strong economic data and lower risk aversion have encouraged investors to move their funds out of the ultra-safe Treasury securities and into stocks, corporate bonds and commodities. This has pushed the 10-year Treasury to 3.45% today, up one percentage point from the recent low of 2.41% just two months ago. This recent run-up in long-term rates highlights the economic truism that the Fed controls short-term interest rates but not longer-term interest rates," Rick told News Now.

"The rise in the 10-year Treasury interest rate over the last couple of months has increased mortgage interest rates. This may have the effect of pushing potential homeowners off the fence and encourage them to pull the trigger and purchase a house before interest rates rise further," he said.

"Higher long-term interest rates have also steepened the yield curve, which is good for credit union net interest margins going forward," Rick added.

The Fed also reiterated its commitment to keeping the fed funds interest rate in their target range of 0% to 0.25% for an extended period of time.

"What is 'an extended period of time'? The fed funds futures market is now pricing in a 25 basis point rate increase by the Federal Reserve at this time next year," Rick said. It also "is pricing in an extension of the Bush tax cuts across the board, a 13-month extension of federal unemployment insurance benefits and other spending increases and tax cuts.

"This is basically an $850 billion fiscal stimulus plan, which along with the Fed's expansionary monetary policy should boost 2011 economic growth to around 4%, up from the previous consensus estimate of 2.5%," Rick said, adding, "This should bring down the unemployment rate to 9% by the end of 2011. Still high, but moving in the right direction."

The committee's move was no surprise. Its statement noted that the economic recovery is continuing,"though at a rate that has been insufficient to bring down unemployment." It recognized that household spending is increasing moderately but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.

"Business spending on equipment and software is rising, though less rapidly than earlier in the year, while investment in nonresidential structures continues to be weak," said the FOMC. "Employers remain reluctant to add to payrolls. The housing sector continues to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have continued to trend downward."

It also noted that the unemployment rate is elevated, and measures of underlying inflation are somewhat low, "Although the committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow," FOMC said.

The $600 billion bond purchases will occur by the end of the second quarter of 2011, a pace of about $75 billion per month," said the committee. "FOMC will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability," the statement said.

In keeping its interest rate the same, FOMC "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 for the federal funds rate for an extended period."

The committee will continue to monitor the nation's economy and "employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate."

Voting for the FOMC monetary policy action were: Ben S. Bernanke, chairman; William C. Dudley, vice chairman; James Bullard; Elizabeth A. Duke; Sandra Pianalto; Sarah Bloom Raskin; Eric S. Rosengren; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen.

Voting against the policy was Thomas M. Hoenig, who was concerned that a continued high level of monetary accommodation would increase the risks of future economic and financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy, the committee said in its statement.

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