Fed Maintains Near-Zero Interest Rate

The Federal Reserve decided Wednesday to keep the target range of its benchmark federal funds rate at 0 to 0.25 percent – a level it’s maintained for a year and a half now.

The continued holding pattern was widely expected, although central bank officials noted in their monetary policy statement that market indicators since their last meeting in April suggest “the economic recovery is proceeding and that the labor market is improving gradually.”

However, that assertion was immediately followed with a long list of negatives that are still weighing heavy on the economy, including high unemployment, lower housing wealth, limited investment in commercial real estate, and a continued contraction in lending.

“Nonetheless, the committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, although the pace of economic recovery is likely to be moderate for a time,” the Fed said.

The central bank held true to the same careful, guarded language surrounding its federal funds interest rate,

which is the rate banks charge each other for loans, noting that economic conditions “are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

As he’s done for many months now, Kansas City Fed Chief Thomas M. Hoenig cast the only dissenting vote on the rate policy action. Hoenig says he believes continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period is no long warranted. He argues that this wording “could lead to a build-up of future imbalances and increase risks to longer-run macroeconomic and financial stability,” according to the Federal Reserve’s decision statement.

The Fed made no reference at all to its mortgage portfolio, which ballooned under the year-long program of buying mortgage-backed securities (MBS) from the GSEs. The program ended in March, and the question on many analysts’ minds has been “how and when will the Fed dispose of its $1.25 trillion in mortgage debt?”

“While we do not foresee the Fed selling MBS anytime soon, it would not be surprising to see the Fed roll bonds,” Barclays Capital said in commentary released to DSNews.com last week.

Barclays also noted that new custody holding data from the Federal Reserve suggest that foreign investment in agency MBS may be increasing after a period of tepid growth – good news for Fannie Mae and Freddie Mac, now that the Fed has exited the secondary mortgage market.

“As central banks are likely diversifying away from euro-denominated assets, dollar denominated assets have benefited tremendously,” Barclays said. “While much of the increases have come in treasuries, recent data suggests that agency MBS holdings of foreign institutions have started to rise sharply as well.”

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