The US Federal Reserve refrained from increasing its $US1.75 trillion bond-purchase program, said the pace of economic contraction is slowing and predicted inflation will remain "subdued for some time."
"Substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time," the Federal Open Market Committee said in a statement after a two-day meeting in Washington where it also kept the benchmark interest rate between zero and 0.25 per cent. The rate will stay at "exceptionally low levels" for an "extended period".
Chairman Ben Bernanke is watching to see how quickly the economy can recover from the deepest recession in five decades: Orders for durable goods unexpectedly rose in May, a government report showed today, while unemployment continues to climb. The Fed also wants to quell concerns that the $1 trillion expansion in its balance sheet will fuel inflation, pushing bond yields higher and crippling any rebound in the economy.
"The Fed wants to be clear they are not raising rates anytime soon," said John Silvia, chief economist at Wachovia Corp. and a former economist in Congress. "They are leaving their options open. The plan is to stay the course at this point in time."
The Fed said "the pace of economic contraction is slowing" and noted "conditions in financial markets have generally improved." The central bank added that it "is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."
Absence of Dissent
Today's decision was unanimous. The Fed's $US300 billion Treasuries-purchase plan is scheduled to end in mid-September, according to the FOMC statement at the conclusion of the March 17-18 meeting, when it was announced. The Fed also committed to buy up to $US1.45 trillion of housing debt this year. At its current rate, the Fed will reach the $US300 billion of Treasuries by late August.
Total assets on the central bank's balance sheet grew $US1.17 trillion over the past year to $US2.07 trillion as the Fed loaned to banks, commercial paper issuers, and purchased bonds outright to support the flow of credit to consumers and businesses.
"This is a very difficult period," said Marvin Goodfriend, a former senior adviser at the Richmond Fed who is now an economist at Carnegie Mellon's Tepper School of Business in Pittsburgh. "The Fed is exposed to a concern about inflation because it hasn't committed itself to a low-inflation objective, yet the Fed may need the flexibility to expand its balance sheet further if the economy underperforms."
Yields
Treasuries fell for the first time in four days, with yields on the 10-year note increasing seven basis points, or 0.07 percentage point, to 3.69 per cent in New York.
While central bankers have indicated they accept the increase as long as it reflects expectations for an economic recovery, a further increase may put such an outcome in jeopardy.
The Standard & Poor's 500 Index pared gains and the Dow Jones Industrial Average fell after the Fed announcement. The S&P 500 rose 0.4 per cent to 898.84 in New York after climbing as much as 1.8 per cent earlier. The Dow declined 37.11 points, or 0.45 per cent, to 8285.80.
Mortgage rates have risen in tandem with yields, potentially delaying a rebound in the housing market. The average 30-year mortgage rate increased to 5.59 per cent earlier this month, the highest since November, before slipping to 5.38 per cent in the week ended June 18, according to Freddie Mac, the McLean, Virginia-based mortgage-finance company.
'Too Low'
"Looking back, we are all cognizant of what transpired in 2003 and 2004 when the Greenspan Fed just left the federal funds rate too low for too long," said Richard Schlanger, a vice president at Pioneer Investment Management in Boston who helps oversee about $US13.5 billion in bonds. Bernanke succeeded Alan Greenspan at the Fed's helm in February 2006.
Bernanke told Congress during testimony on June 3 that the Fed "will not monetise" US debt, addressing concern that the central bank's purchases of government debt might be used to finance deficit spending. Measures of overall inflation retreated in April while so-called core prices rose.
The personal consumption expenditures price index rose 0.4 percent for the year ending April. Oil prices tumbled from an average price of $112 a barrel in April last year to an average of around $50 a barrel the same month this year. Prices minus food and energy rose 1.9 percent for the year ending April.
FOMC Challenge
"The challenge for us on the Federal Open Market Committee will be to shrink our balance sheet and tighten policy soon enough when the recovery emerges to prevent rising inflation," Richmond Fed President Jeffrey Lacker said in speech in Raleigh, North Carolina, on June 10.
Inflation expectations have also increased. One such measure, the difference between yields on 10-year Treasuries and 10-year inflation-linked US notes, rose to 1.84 per cent yesterday from 1.41 percentage point at the start of last month.
Fed officials revised their estimates for growth, unemployment and inflation at today's meeting. Their new forecasts will be available when the Fed publishes meeting minutes next month.
Private forecasters expect the economy to grow 1.9 per cent next year, with inflation at 1.8 per cent, according to the median estimates in a Bloomberg News survey. The unemployment rate will rise further, averaging 9.7 per cent for 2010, according to economists in the survey. The jobless rate stood at 9.4 percent in May, the highest since 1983.
Wealth Destruction
Job losses and record wealth destruction suggest consumer spending may not sustain the gains reported in the first quarter. Department stores Macy's and Dillard's and luxury chain Saks reported on June 4 that sales declined more than forecast in May. FedEx Corp. said last week that profits will trail analysts' estimates because of an "extremely difficult" economy.
"A slow economic recovery is still a recovery, and sooner or later the Fed will take back their emergency rate cuts," said Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York. "As long as the low rates Fed pledge is conditional on the economic outlook, those green shoots are going to drive investors out of bonds."
Money-market futures contracts show traders see a higher probability of a Fed rate increase in early 2010 than they did a month ago. Still, current data contain few signs that the economy will rapidly turn from recession to growth and accelerating consumer prices.
Consumers Pulled Back
Industrial capacity use rates fell to a record low in May. Consumers pulled back on spending in both April and March as falling home prices, tighter credit, and high unemployment reduced confidence.
"The market sometimes gets ahead of itself, and this is one of those times," Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pennsylvania, said before the announcement. "We will see core inflation continue to moderate given high and rising unemployment and excess capacity in almost every corner of the economy."