The markets were jittery all morning, waiting for the announcement following the close of a two-day meeting of the Federal Open Market Committee (FOMC), the Fed’s policy arm. Usually such anxiety is stirred by the prospect of a change in the fed funds rate, but this time everyone knew the target would stay at 0.00% to 0.25%. Instead, the focus was on how the Fed would react to an economy no longer in free fall.
The first paragraph of the FOMC statement, when it finally came, was a balanced capsule summary of present conditions. The “pace of economic contraction is slowing,” consumer spending is “stabilizing,” and businesses are aligning inventories with sales. Weighing against these gains are “ongoing job losses,” “tight credit,” and cutbacks in business spending on fixed assets. In short, the economy remains very fragile and downside risks abound, but a bottom has been reached. The FOMC’s conclusion is that under these conditions “inflation will remain subdued for some time.” Fed officials are no longer worried about deflation, even though the Consumer Price Index has fallen 1.3% in the last year. But they remain convinced that further monetary stimulus is necessary and that their policies “will contribute to a gradual resumption of sustained economic growth.” That’s why the fed funds target will stay near zero, and the Fed will continue its program of buying $1.25 trillion of Treasury and Agency securities.
The markets have not reacted well to the FOMC announcement because no one got quite what they wanted. Inflation hawks wanted some indication of when fed funds rates would rise. Those worried about the recession continuing were hoping the Fed would commit even more than $1.25 trillion of liquidity. In the end, the Fed went down the middle and both stocks and bonds fell.