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Confused about the news coming from today’s Federal Reserve Open Market Committee (FOMC) meeting? So were we! But after some careful analysis of  market reaction and the Federal Reserve’s press release, we’re ready to help simplify!

Overall what you need to know is this:

Ever since Federal  Reserve Chairman Ben Bernanke hinted in mid October that the Fed would take steps to improve the economy, the markets have been prematurely celebrating, baking in the anticipation of an influx of treasury purchases.

Today’s FOMC announcement, however, wasn’t quite as generous as hoped, so markets – and mortgage rates – reacted by trending a bit in the opposite direction as a correction.  Mortgage rates ticked upward, but are expected to stabilize. Where they land is anyone’s guess, but in the meantime,  there’s no doubt that it’s a great time to refinance to historically low rates.

Here’s our official translation of the official Federal Reserve press release. (Our part in bold!)

Federal Reserve Press Release

Release Date: November 3, 2010

Information received since the Federal Open Market Committee met in September confirms that the pace of recovery in output and employment continues to be slow. Household spending is increasing gradually, 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. Employers remain reluctant to add to payrolls. Housing starts continue to be depressed. Longer-term inflation expectations have remained stable, but measures of underlying inflation have trended lower in recent quarters.

This is the “sad country song” paragraph.  They lay out all things that are wrong with the economy. 

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. 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.

The Fed has two goals.  1) Try to stimulate employment as much as possible and 2) Try to keep inflation (prices) under control.  The Fed is saying here that they are WAY more worried about #1 (jobs) than they are about #2 (rising prices).

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee 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.

Usually, if the Fed wants to give the economy a push (by creating more jobs), they lower short term interest rates (makes borrowing cheaper so people borrow and then spend money, creating economic growth).  But short term interest rates are now 0%.  Can’t go lower than that – so, what to do?! 

Well… the Fed is saying that they are going to reach into their bag of tricks and  start up the printing presses to print money they’ll use to buy Treasury bonds.  When they compete with other buyers to buy those bonds, the price of those bonds go up (just like the price of anything in demand goes up).  When bond prices go up, the yields (rates) go down.  So, the Fed is using this trick to drive longer term Treasury rates down.  This should also keep other longer term rates (like mortgages) down as well.

However, mortgage rates went up a bit right after the announcement. Why would that be?  Well, the market may have expected more – and since the market ANTICIPATED this move ahead of time, they’ve been driving mortgage rates down for some time in anticipation of this. 

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and 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.

Short term rates will stay at 0% for quite a while…

The Committee will continue to monitor the economic outlook and financial developments and will 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.

The Fed says they will continue to do their job. 

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.

This simply means: everyone did not agree!

Voting against the policy was Thomas M. Hoenig. Mr. Hoenig believed the risks of additional securities purchases outweighed the benefits. Mr. Hoenig also was concerned that this continued high level of monetary accommodation increased the risks of future financial imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy.

Tommy Hoenig thinks prices could rise and he’s freaked out that low rates and printing money could lead to inflation.  

Thanks for reading! Come back for more translations as the story of our economy unfolds!!!


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