The Federal Reserve's (Fed's) monetary policymaking body announced, in September, that it had launched a third program of open-ended bond purchases (quantitative easing or QE3) at a pace of $40 billion a month. It also extended its Operation Twist policy, and said it would likely, if warranted, extend its targeted federal funds rate at 0% to 0.25% until mid-2015. These decisions will continue to affect credit unions, said Bill Hampel, Credit Union National Association's (CUNA) chief economist.
The Federal Open Market Committee (FOMC) made the announcements at the conclusion of two days of meetings. The committee said it expected that a "highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens." It kept the target range for the federal funds rate at 0% to 0.25% -- the level the rate has been at since December 2008--and said it "currently anticipates that exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015."
"Thursday's [September 13] announcement by the Fed likely has less to do with the current state of the U.S. economy than it does with the risks the economy faces from a possible collapse of the Eurozone, or falling off the fiscal cliff at the end of the year," Hampel told News Now. "That refers to the fact that Congress could plunge the U.S. economy into another recession if it doesn't act to stop a huge fiscal ‘de-stimulus’ of dramatic tax increases and spending cuts set to take place next January.
"By its action, the Fed appears to be saying it will bring whatever tools it has left to try to offset either of these shocks to the economy. The emphasis the Fed placed on weakness in the employment picture rather than simply the economy as a whole also makes this a stronger statement," Hampel said.
Hampel noted that "the FOMC's announcement further complicates the already vexing task of interest-rate-risk management for credit unions. Long-term interest rates will stay lower, for longer, based on the Fed's actions. This will further compress interest rates, reducing the opportunity for net interest income, the difference between the interest yield on assets and the interest cost of funds. The fact that it may be a while longer before interest rates finally rise doesn't change the fact that once they do, they will have even further to rise.
"In other words, the pressures on credit unions to take on even longer term loans and investments in order to protect current interest income will be coupled with an even greater threat of rising interest rates, which will be very harmful to institutions with long average asset maturities," he said.
"Of course, the important issue is when will interest rates begin to rise. Caution should be taken in interpreting the Fed's mid-2015 statement," Hampel added, noting that committee members "did not pledge to keep interest rates at their current very low levels until then, as is frequently reported. Instead, they said they believe very low interest rates 'are likely to be warranted' at least until then.
"What that means is they believe the labor market will not get back toward full employment for three more years. But, rest assured, if the unemployment rate improves more rapidly than they expect, they will raise rates sooner than mid-2015," he said.
The FOMC also decided to extend the average maturity of its holdings of Treasury securities as announced in June, and to maintain its existing Operation Twist policy of reinvesting principal payments from the Federal Reserve's holdings of agency debt and agency mortgage-backed securities (MBS) in agency MBS.
It noted that these actions "together will increase the committee's holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."
In explaining its decisions, the committee said that economic activity has "continued to expand at a moderate pace in recent months." It recognized slow employment and an elevated unemployment rate, and noted that household spending has continued to advance, but growth in business fixed investment appears to have slowed. "The housing sector has shown some further signs of improvement, albeit from a depressed level. Inflation has been subdued, although the prices of some key commodities have increased recently," said the committee's press release.
The FOMC also stated it "is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions. Furthermore, strains in global financial markets continue to lose significant downside risks to the economic look." It expects the inflation over the medium term would run at or below its 2% objective.
The committee will "closely monitor incoming information on economic and financial developments in coming months. If the outlook for the labor market does not improve substantially, the committee will continue its purchases of agency MBS, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability. In determining the size, pace, and composition of its asset purchases, the committee will, as always, take appropriate account of the likely efficacy and costs of such purchases."
Voting for the FOMC monetary policy action were: Chairman Ben S. Bernanke, Vice Chairman William C. Dudley; Elizabeth A. Duke, Dennis P. Lockhart, Sandra Pianalto, Jerome H. Powell, Sarah Bloom Raskin, Jeremy C. Stein, Daniel K. Tarullo, John C. Williams, and Janet L. Yellen.
Voting against the action was Jeffrey M. Lacker, who opposed additional asset purchases and preferred to omit the description of the time period over which exceptionally low levels for the federal funds rate are likely to be warranted.
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