Fed Keeps Interest Rate at a Record Low

The U.S. Federal Reserve kept its benchmark interest rate unchanged at the 0.25%-0% range. “Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower”, the Fed said. Apparently, the U.S. dollar seems to be reacting positively to the rate announcement judging by the drop in the EUR/USD. However, price action often reverses its course after a news release since investor’s expectations for rate decisions are already discounted on exchange rates

source: Tradestation

FOMC Statement Highlights from DailyFX

The U.S. dollar had been under selling pressure ahead of today’s rate decision on speculation the Fed would announce new measures of quantitative easing which could demolish the safe-haven status of the greenback. Quantitative easing has many short-term benefits but foreign investors have begun to express their concern about the long term fiscal sustainability of this policy by selling dollars. Indeed, investors have good reasons to be concerned since the Federal Reserve has been actively purchasing large quantities of government debt, agency debt and mortgage-backed securities to provide support to the mortgage and housing markets. In detail, at its last FOMC meeting, the Fed decided to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year. Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. However, investor’s concern didn’t quite materialize in today’s FOMC statement. Below is a copy of the FOMC statement with highlights from the DailyFX team.

FOMC Press Release, April 29, 2009

"Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower. Household spending has shown signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Weak sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories, fixed investment, and staffing. Although the economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time. Nonetheless, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is facilitating the extension of credit to households and businesses and supporting the functioning of financial markets through a range of liquidity programs. The Committee will continue to carefully monitor the size and composition of the Federal Reserve's balance sheet in light of financial and economic developments.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Donald L. Kohn; Jeffrey M. Lacker; Dennis P. Lockhart; Daniel K. Tarullo; Kevin M. Warsh; and Janet L. Yellen."

Long Term Forecast for the U.S. dollar

Despite the recent gains made by major stock market indices and despite the uptick in several economic indicators, the U.S. economy is still facing the largest economic downturn since the 1930s. Since the recession began in December 2007, more than 5 million jobs have been lost and the total number of unemployed persons in the United States is now estimated at 13.2 million. Still, even though a worsening of economic conditions in the United States may lead to further losses in stocks and commodities, it does not imply that the U.S. dollar exchange rate must depreciate against other currencies. In fact, during the last 12 months the U.S. dollar appreciated substantially against several of the world’s most heavily traded currencies because investors were reluctant to take leveraged positions on riskier currencies. In general, periods of severe economic crisis often lead to political instability in certain parts of the world and a sudden increase in investor’s uncertainty towards the future of the world economy may possibly trigger a new wave of flight-to-quality in the form of U.S. Treasuries purchases. Having said that, a strong demand from financial institutions seeking a safe-haven currency is likely to keep the U.S. dollar well supported in the second half of 2009.

Antonio Sousa is a Chief Strategist for DailyFX.com at FXCM in New York City where he performs global economics research and develops systematic trading strategies.