3 Important Points From the Fed's Announcement
Dec 12th 2012 3:59PM
Updated Dec 12th 2012 4:06PM
Love it or hate it, the Federal Reserve matters. Earlier today, the central bank concluded its two-day policy meeting and has released a statement with the steps that it will take over the foreseeable future pursuant to its dual mandate to minimize unemployment and maintain price stability. What follows are three important takeaways from the Fed's announcement.
1. The economic recovery is a study of contradictions
One of the most interesting aspects of the ongoing recovery is that it's not evenly distributed. In a recent interview with my colleague Morgan Housel, for example, investing great Mohnish Pabrai of Pabrai Funds observed that new-car sales are at record levels even though the real unemployment rate remains in the double-digits. Here's how the Fed put it:
Information received since the Federal Open Market Committee met in October suggests that economic activity and employment have continued to expand at a moderate pace in recent months, apart from weather-related disruptions. Although the unemployment rate has declined somewhat since the summer, it remains elevated. Household spending has continued to advance, and the housing sector has shown further signs of improvement, but growth in business fixed investment has slowed.
In other words, some things are going good, while others are going bad. But on average, it's weighted toward the latter.
2. To QE-infinity... and beyond
Since the onset of the financial crisis, the Fed has provided an unprecedented amount of support to the U.S. economy. It made liquidity available to virtually all of Wall Street when credit markets froze, worked hand-in-hand with the Treasury Department to prop up ailing financial firms with capital injections, increased its regulatory role over banks, and had, until today, previously initiated three rounds of quantitative easing. All told, in turn, the Fed's balance has more than tripled in size over the last five years, going from roughly $900 billion in September of 2008 up to $2.8 trillion currently.
Today's announcement marks an further step in this direction. Following the expiration of Operation Twist, under which the Fed sold short-term assets to purchase securities with a longer maturity, it will initiate a fourth round of quantitative easing "initially at a pace of $45 billion a month." This program, moreover, will run concurrent with QE3, the bank's ongoing monthly purchases of $40 billion in mortgage-backed securities issued by Fannie Mae and Freddie Mac.
According to the Fed: "These actions should maintain downward pressure on long-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."
3. New targets
Finally, and most notably in terms of a lasting significance, the Fed took the bold step of tying its monetary policy decisions to specific economic targets. Under the conditions announced today, it will keep short-term interest rates low so long as the unemployment rate remains above 6.5% and inflation below 2.5%. Here's how the official press release put it:
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0% to 0.25% and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2% longer-run goal, and longer-term inflation expectations continue to be well anchored.
While the move marks another step in the direction of increased transparency, a hallmark of Bernanke's time there, it will most likely be known as the "Evans rule," after Chicago Fed President Charles Evans. Evans first floated the idea back in September of 2011. Though, at the time, he recommended benchmarks of 7% and 3%, respectively, he subsequently revised it last month to the current levels because, as he put it, 3% inflation "makes many people anxious."
Why this matters
On the heels of this news, it should be no surprise that shares of many financial companies are trading higher, with all four of the big banks -- JPMorgan Chase , Bank of America , Citigroup , and Wells Fargo -- in the green for the day. The most notable laggard is Goldman Sachs , which is marginally down as we approach the close. Because banks control the narrows between savers and spenders, any policy like the one above that's designed to boost the latter group is good for banks.
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The article 3 Important Points From the Fed's Announcement originally appeared on Fool.com.John Maxfield owns shares of Bank of America. The Motley Fool owns shares of Bank of America, Citigroup, JPMorgan Chase, and Wells Fargo. Motley Fool newsletter services recommend Goldman Sachs Group and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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