As the once free-falling economy shows tentative signs of stability, economists and investors are wondering when the Federal Reserve will reverse course and begin raising interest rates. But in a statement Wednesday after its meeting in Washington, the central bank's Federal Open Market Committee moved to maintain its benchmark interest rate at as low as zero percent, and pledged to keep rates at "exceptionally low levels" for "an extended period" of time. "While the language was subtle, the clear message is to keep inflationary concerns to a minimum and to curb talk of higher rates," Michael Woolfolk, a senior currency strategist at The Bank of New York Mellon, said in a report. "The Fed has no intention of reversing its zero interest rate policy or quantitative easing measures before the end of the year." Here are five things to know about the development.
[Check out Mortgage Rates Seen Below 6% Through 2010]
1. Extended period: While reiterating its plans to keep rates low for quite some time, the Fed on Wednesday went a step further than it had in previous statements by laying out three key factors--"low rates of resource utilization, subdued inflation trends, and stable inflation expectations"--behind its outlook. By communicating its reasons for keeping rates so low, the Fed is also calling attention to the specific factors it will use to determine when--and by how much--to increase rates. "The Fed will reconsider this stance over time if growth utilization rates rise significantly, or if inflation or inflation expectations begin to increase in a way that threatens the Fed's price stability objective," Dean Maki, of Barclays Capital Research, said in a report. "Importantly, the statement suggests the Fed will not be raising rates in the near term even as economic growth picks up, given that levels of resource utilization are likely to remain low for some time even if growth is solid."
2. Next hike? In light of the parameters that the Fed is using, economists don't expect the central bank to start jacking up rates for several months at least. "Given our forecast that the unemployment rate will very soon reach a peak and inflation will be moving upward in 2010, the Fed statement is consistent with our view that the Fed will begin to lift the federal funds rate sometime in the Spring or early Summer," Brian Wesbury, chief economist at First Trust Advisors, said in a report. "The statement does not lead us to change our view that the Fed will keep rates unchanged until the September 2010 meeting, when we expect the first rate hike," Maki said.
3. Asset purchase reduction: The Fed also announced that it would reduce the size of its previously announced program to buy debt in Fannie Mae and Freddie Mac by roughly $25 billion, to a total of $175 billion. "However, we do not see this as a first step toward an exit strategy but, rather, as the beginning of the end of the beginning--the Fed is still in easing mode as their balance sheet continues to expand," Drew Matus, a senior U.S. economist at BofA Merrill Lynch Global Research, said in a report. "Indeed, even with this adjustment the Fed balance sheet should peak above $2.6 trillion at the end of March 2010."
4. Interest rate outlook: Keith Gumbinger, of HSH.com, said there was nothing in the Fed's announcement that would alter his near term outlook for mortgage rates. Gumbinger expects 30-year fixed mortgage rates to remain in an attractive range of between 5 percent and 5.25 percent through the end of March 2010. "As we move past that March expiry for the Fed's [mortgage backed security purchase] program, that's when things could get a little dicey," he says.
5. Program extension: The Fed's program to buy mortgage-backed securities from Fannie Mae and Freddie Mac, which was first announced in November 2008, is one of the main reasons mortgage rates have been so attractive for nearly the past year. Although the Fed recently moved to extend the program through the end of March, some observers worry that a lack of private demand for such assets could trigger sharply higher mortgage rates once it expires. The Fed, of course, could always decide to expand the program again. But the decision to do so will depend on what the economy looks like in a couple months, says Zach Pandl, an economist at Nomura Securities. "If it looks like inflation is very low and that this very high unemployment rate [and] large output gap [are] putting downward pressure on inflation, then maybe there is need to jolt activity a little bit more with purchases," Pandl says.