Term Asset-Backed Securities Loan Facility

No Surprises From the Fed Liz Ann Sonders Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.   June 23, 2010 Key points No surprises from the Fed today, but one dissenter remains. First statement since recovery unfolded in which Fed had to dial back its language about recovery's pace. Both equity and fixed income investors have something to cheer … for now anyway. The Federal Open Market Committee surprised no one with its decision, announced today, to keep the Fed funds target rate in a range between zero and 0.25%, where it's been since December 2008. The Fed also kept the much-watched "extended period" phrase in its accompanying statement, suggesting it remains in no rush to normalize interest rates from their emergency level. Stocks rallied immediately after the announcement, but in light of rampant intraday volatility lately, it's way too soon to judge if there will be any longer-term impact. The 10-year US Treasury yield fell to its lowest level this year after the announcement, closing at 3.11%. Yields were also likely pushed down as a result of today's weak new home sales report. Remember, bond yields and prices move in the opposite direction. The Fed did touch on global pressures, stating that "The economic recovery is proceeding" and "the labor market is improving gradually," but also noting that "financial conditions have become less supportive of economic growth on balance, largely reflecting developments abroad." That last part was a new addition to the statement, but no surprise in light of the eurozone debt crisis and its impact on credit spreads globally. It was the first time since the economic recovery began last summer that the Fed had to slightly dial back its language about the pace of the recovery. The statement repeated that inflation is "likely to be subdued for some time," newly adding that "prices of energy and other commodities have declined somewhat in recent months, and underlying inflation has trended lower." Remember, employment and inflation are two of the key determinants of the Fed's decision-making. We've had a distinctly disinflation/deflation view for some time, so to see the Fed address the decline in inflation further is in keeping with our analysis. For the fourth consecutive meeting, there was one dissenter, Kansas City Federal Reserve Bank President Thomas Hoenig, who reiterated his view that the low-rate "pledge" could fuel asset price bubbles and limit the Fed's flexibility to raise rates in the future. Although we have a benign inflation outlook, we too worry about asset price inflation and its destabilizing effects. Some Fed watchers were expecting a comment on the Fed's remaining open emergency lending program—the Term Asset-Backed Securities Loan Facility —which has been scheduled to close on June 30. The program was designed to aid the commercial real estate market, which has stabilized, by subsidizing investor purchases of mortgage-backed securities. Although the eurozone debt crisis has the potential to stall the global economic recovery, the Fed appears to be closing that facility on schedule. According to a Bloomberg News survey of economists this month, the average estimate for the first rate hike has been pushed to the first quarter of 2011. Before the eurozone debt crisis, the expectation had been for the first hike coming in the latter half of 2010. We can't quibble with the economists' consensus, but continue to feel the Fed will be data-driven, and if the data shows either significant improvement to labor conditions and/or significant deterioration in inflation conditions, the Fed could be quicker than expected to pull the rate trigger.