Fed Stays the Course, But With a Few Tweaks

There were some minor tweaks to the Federal Reserve's statement today, but otherwise the major thrust of the Fed's extraordinary policy to combat the financial crisis remains in place: keeping interest rates "exceptionally low .... for an extended period" and continuing massive purchases of treasuries and mortgage-backed securities.

Among the notable tweaks, the Fed appeared to dial back on its concerns over deflation. It removed from its statement the line from April where it worried that there was "some risk that inflation could persist for a time below rates that best foster economic growth and price stability." That was code for deflation concerns.


In another change of note, the Fed pushed back on some of the market's inflation concerns. It noted that energy and commodity prices have risen, but said that "substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time." That's a direct rebuke to those who see incipient inflation in higher oil and gold prices.

Perhaps most interesting was what was left out of the memo. There was no talk of exit strategy, or how the Fed plans to unwind the huge increase of its balance sheet from around $800 billion to over $2 trillion now. Several Fed officials have said the Central Bank plans to talk seriously about exit strategies this summer. So, maybe they talked about it at the June two-day meeting, but they are just not ready to tell us what they are saying.

The other omission was the failure to change or offer any guidance on plans by the Fed to stop buying treasuries in the autumn. The Fed had said it would purchase up to $300 billion of U.S. treasuries, of which it's purchased $160 billion. It's on pace to complete those purchases by August or September. The Fed's failure to offer any guidance now means that the market will have to guess about whether the program will be continued until the next statement on August 12. By then, the Fed could be most of the way through its $300 billion of purchases and bond markets will have to guess at what happens next.

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(Note in the video below that Bill Gross said on CNBC today he thinks the Fed is going to have to buy treasuries for years to come and warned that the government would have trouble placing its debt if the Fed stopped.)

Finally, the statement did offer one new upbeat note. It said "financial markets have generally improved" but otherwise repeated the lukewarm economic assessment of from the April statement that offered only that the "pace of economic contraction is slowing."

All of this sets up Fed Chairman Ben Bernanke's late July, semi-annual testimony to Congress as critical. It's when we are likely to get the next set of critical clues about the direction of Fed policy in the financial crisis.