Cautiously optimistic Fed holds rates fast

Fed Chairman Ben Bernanke and his fellow colleagues said they have leeway to hold rates at record lows because inflation is likely to stay subdued because of “slack” in the economy.  Factories and other businesses are operating well below full throttle. Workers aren’t likely to see hefty pay raises any time soon. And companies are wary of jacking up prices because consumers haven’t shown signs of returning to their free-spending ways.  Once the economy is on firm footing, the Fed will need to start boosting rates to prevent inflation and bring policy closer to normal. Economists still think that is months away.  Mark Zandi, chief economist at Moody’s Analytics, was among analysts who said they thought Greece’s debt crisis is one reason why the Fed is proceeding with caution, even though it didn’t mention the debt crisis in its statement.

Nonetheless, signals are growing that the U.S. economy has turned a corner. Employers added a net total of 162,000 job in March, the most in three years. Americans’ confidence is rising, and they are spending more. Manufacturers are boosting production. And a rising number of companies — such as Ford, Caterpillar and UPS — are seeing their profits grow.  Given the economy’s improvements, Chris Rupkey, economist at the Bank of Tokyo-Mitsubishi, expressed disappointment that the Fed didn’t send a signal that higher rates are on the way.  “We think they should have lifted their foot off the gas pedal a little,” he said.  A month ago, Rupkey thought the Fed would start boosting rates in June. But based on the Fed’s renewed pledge Wednesday to keep rates at record lows for an “extended period,” he now thinks August is the earliest it might happen.

The Fed provided no clues about when it will start shedding some of its vast portfolio of mortgage securities. Doing so would tighten credit by sopping up some of the unprecedented amount of money that was pumped into the economy during the financial crisis.  The Fed has bought $1.25 trillion of these securities to drive down mortgage rates and aid the housing market. Its challenge is to sell those assets in a way that doesn’t weaken home prices and jack up mortgage rates. There’s been disagreements within the Fed about the timing and method of such sales.  The Fed’s balance sheet has exploded, reflecting the central bank’s action to fight the financial crisis. It stood at $2.3 trillion for the recent week, more than double the level before the crisis struck.  In its statement, the Fed once again said the pace of the recovery will likely remain moderate. The Fed wants to see lower unemployment and consistent job growth before it considers a rate increase, analysts say.

The unemployment rate, now 9.7 percent, is expected to remain high. Neither economic growth nor job creation is expected to be robust enough to quickly drive the rate down.  “While I believe that the Fed will have to raise rates this year, unless the job market improves a lot more quickly than expected, that just may not happen,” said economist Joel Naroff, president of Naroff Economics Advisors.

Information received since the Federal Open Market Committee met in March suggests that economic activity has continued to strengthen and that the labor market is beginning to improve. Growth in household spending has picked up recently but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit. Business spending on equipment and software has risen significantly; however, investment in nonresidential structures is declining and employers remain reluctant to add to payrolls. Housing starts have edged up but remain at a depressed level. While bank lending continues to contract, financial market conditions remain supportive of economic growth. Although the pace of economic recovery is likely to be moderate for a time, the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability.  With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.

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 of the federal funds rate for an extended period. The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.

In light of improved functioning of financial markets, the Federal Reserve has closed all but one of the special liquidity facilities that it created to support markets during the crisis. The only remaining such program, the Term Asset-Backed Securities Loan Facility, is scheduled to close on June 30 for loans backed by new-issue commercial mortgage-backed securities; it closed on March 31 for loans backed by all other types of collateral.

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