FOMC Stands Pat, Acknowledges Credit Crunch

Wednesday, August 08, 2007

The Federal Open Market Committee (FOMC) decided to leave the Fed Funds rate unchanged at 5.25%.
The statement equals the one from the July meeting except for one new sentence in which the FOMC acknowledged that investors and consumers are suffering from tighter credit. Apart from that the FOMC kept its cautionary outlook unchanged, saying that economic growth was moderate in the first half of 2007 while the correction in housing was ongoing.
The complete statement:
The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.
Economic growth was moderate during the first half of the year. Financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing. Nevertheless, the economy seems likely to continue to expand at a moderate pace over coming quarters, supported by solid growth in employment and incomes and a robust global economy.
Readings on core inflation have improved modestly in recent months. However, a sustained moderation in inflation pressures has yet to be convincingly demonstrated. Moreover, the high level of resource utilization has the potential to sustain those pressures.
Although the downside risks to growth have increased somewhat, the Committee's predominant policy concern remains the risk that inflation will fail to moderate as expected. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; Michael H. Moskow; William Poole; Eric Rosengren; and Kevin M. Warsh.
The Fed's decision comes amid a string of not too good looking economic indicators.
Last Friday the BLS reported an increase in the unemployment rate to 4.6%. 11 months earlier unemploment had stood at 4.4%.
Productivity has picked up in June though, with a monthly gain of 0.5% (May: minus 0.1%), but still below analysts expectations.
Average hourly earnings came in 6 cents or 0.3% higher.
Capacity utilization for total industry moved up to 81.7 percent in June; the rate was 0.6 percentage points below its level in June 2006 but 0.7 percentage points above its 1972-2006 average.
With inflation outpacing earnings consumers have to look for other sources to raise the money needed for mortgage payments, especially when about haf of all variable mortgages are in for a costly hike in interest in the next 16 months.
The temporary solution was a rush into more debts by extending their consumer loans. The Fed's monthly release of consumer credit data on Tuesday shows a slightly lower growth rate of 6.5% (May: 7.9%) with revolving (credit card) loans expanding relatively faster than traditional loans.
Loan growth can be expected to slow in line with mortgages as lenders have been upping their lending standards in the face of higher rates.
Markets showed initial relief that the Fed has stuck to its rhetoric of moderating growth, which provides a steady Fed funds outlook.
I am not buying into that optimism as the status of all economic worries has not changed with the latest set of indicators as I am worried about credit markets. The recent partial normalization of the yield curve has not come along with an improved rate outlook but was rather inspired by a flight to Treasuries amidst the subprime meltdown that has reached Alt-A lenders by now. Until now 110 mortgage lenders have thrown in the towel, according to Implode-O-Meter.

10 Year Treasury Yield

GRAPH: Is the 10-year Treasury yield ready for another up-leg after the roller coaster ride since May? Chart courtesy of
Share markets appeared resilient to the modest growth and even interest rate outlook and rose marginally. I would say the Fed has done all it can do now.


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