Wednesday, March 17, 2010

The Fed's Move: Expected and Unexpected All At the Same Time

Yesterday's Fed statement following the FOMC meeting offered little in the way of surprising news. Sort of. Traders and investors were focused on two things:
  1. Would the Fed remove the statement about keeping interest rates low for an extended period of time? (It left it in.)
  2. Would the Fed end its purchases of mortgages as scheduled by the end of the month or extend its quantitative easing further? (It chose to end the program.)
It seems somewhat contradictory that the Fed would both end the purchase program AND plan to keep interest rates at zero, yet this is exactly what it did. The Fed justified its moves by stating that "Economic activity has continued to strengthen. The labor market is stabilizing." And "Inflation is likely to be subdued for some time." Now that economic activity has picked up, the Fed thinks it can end its quantitative easing program, yet leave interest rates at zero all without causing inflation. You see, it's a "Goldilocks Economy." Growth is not too high, not too low, it's just right. Besides, if inflation does pick up, the Fed will know exactly what to do to stop it in its tracks without causing another meltdown in the markets. The Fed is really good at this type of thing, right? Remember the last time we had a Goldilocks economy from 2004-2007, and how well the Fed handled "easing" us into a recovery after asset price inflation got a wee bit overheated? It'll probably go something like that.

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