The Fed Fine-Tunes Its Juggling Act

America's money chief Ben Bernanke tried to make everybody happy on June 24, telling the inflation doves that he's not planning to pick up short-term interest rates off the floor anytime soon while signaling to inflation hawks that the Federal Reserve does have a plan if prices start rising. The occasion was the widely anticipated announcement at the conclusion of a two-day meeting in Washington of the Fed's rate-setting Federal Open Market Committee.

The Fed chairman managed to get unanimity at least within the Fed itself, as all of the voters on the open market committee—doves and hawks alike—went along with the announcement. The carefully worded statement closely resembled the committee's last one on Apr. 29, signaling that the Fed isn't making any big changes in direction.

The stock market took the Fed's action more or less in stride. The Standard & Poor's 500-stock index fell about 1% right after the statement's release at 2:15 p.m. Eastern time but then gained back most of that loss by late in the session. "Fed sticks to its guns" was the headline on an instant analysis from Capital Economics. Wachovia Chief Economist John Silvia released a statement saying that Wachovia isn't expecting the Fed to raise rates at all this year.

Lots of Excess Supply

HSBC Chief U.S. Economist Ian Morris said the statement contained "a few small nods to the hawks," who worry that inflation will start rising soon. There was a stronger statement that the economic contraction is slowing, acknowledgment that energy and other commodity prices are up, and a note that companies are having some luck in getting excess inventories under control. In a nod to the doves, The Fed said "substantial resource slack is likely to dampen cost pressures." That's another way of saying that it's hard to raise prices because there's a lot of excess supply.

The Fed is still trying to stimulate growth by keeping its target for the federal funds rate at a record low range of zero to 0.25%—no surprise there, given the deepness of the U.S. recession. What was more interesting to the financial markets was that the Fed is staying the course, for now, on its plan to hold down longer-term interest rates by buying 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. ("Agency" is lingo for companies like Fannie Mae and Freddie Mac that raise money from investors to buy mortgages from banks.) In addition, the Federal Reserve is still planning to buy up to $300 billion of Treasury securities by autumn.

Some hawks had feared that the rate-setting committee would announce a plan to step up its purchases of agency and Treasury debt. Instead, the Fed said it "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." That means it could either raise or cut the purchases as needed, says economist Richard DeKaser, head of Woodley Park Research. For good measure, the Fed added, "The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted."

Low Rates Ahead

But the Fed also reached out to the doves by saying it's not ready to start jacking up rates anytime soon. The committee said that it "continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."