Fed Takes Baby Steps

The Fed kept their benchmark rate unchanged, saying that it will remain there for an extended period of time. As usual, they repeated their plans to end most of their short-term emergency lending programs and their asset purchases. They maintained their cautious tone, warning that employment is still weak and that bank lending continues to contract.

However, compared to their previous rate statement, the recent one was a bit more optimistic. According to the Fed, economic conditions continue to strengthen while business spending on equipment and software is picking up. If you ask me, this sounds much more upbeat than their previous commentary, which said that the economy is picking up and that businesses are cutting back on investment at a slower pace.

But wait, there’s more! Seems like there’s some dissent amongst the ranks!

Apparently, Thomas Hoenig, president of the Federal Reserve in Kansas City, disagrees with the FOMC‘s commitment to keep interest rates steady for an extended period. He believes that the ultra-accommodative monetary policy of the Fed will eventually cause inflation to surge to uncontrollable levels, ultimately restraining the ongoing economic recovery.

Even though Thomas Hoenig isn’t part of the FOMC, I believe his words are significant because it indicates that the US economy is doing better. Does this mean that the US economy can finally do away without economic stimulus measures and stand on its own feet?! After all, the Fed did say they will be ending some of their stimulus measures come March 31.

Hoenig also cited that GDP growth is expected to have hit a juicy 4.5% during the 4th quarter. This would be probably good enough to overshadow the downward revision in the 3rd quarter GDP from 3.5% to just 2.2% growth. The rise in the past quarter is being attributed to companies building up their inventories which were sliced and diced during the recession.

It’s no surprise that Hoenig pointed to this data as evidence to support his claims that the Fed should hike rates because, if the GDP figure meets expectations, it would mark the largest increase in SIX years! Still, some are wary that this strong growth will be unsustainable. Plus, being the Advance GDP report, the actual reading may be significantly be revised lower once the Final GDP release comes out in March.

Now, with the Fed ending its purchase of $1.25 trillion of mortgage-backed securities and about $175 billion of agency debt in March, the central bank may switch back to its “wait and see” mode to check how much impact these exit strategies will have on the market. Of course, lifting these programs effectively removes some of the liquidity in the system which then could put a drag on the markets. If the economy remains robust without these supports then perhaps the Fed could already start thinking about raising their rates.

But before that, the FOMC will once again meet on the second week of March to decide on their monetary policies. Between today and their next meeting, it’s kind of unlikely for the growth in the US economy to accelerate any faster since China, one of its major trading partners, has already begun tightening their policies. Given this, and perhaps with a little help from my crystal ball, I foresee that the Fed will most likely stick with the status quo in terms of their monetary policies.

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