Wednesday, November 4, 2009

The Fed maintains a sweet spot

From FOMC Statement

On the real economy:
  • Economic activity has continued to pick up.
  • Conditions in financial markets were roughly unchanged.
  • Activity in the housing sector has increased over recent months.
  • Household spending appears to be expanding but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit.
  • Businesses are still cutting back on fixed investment and staffing, though at a slower pace
  • Businesses continue to make progress in bringing inventory stocks into better alignment with sales.
On inflation:
With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.

Monetary policies:
The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

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 $1.25 trillion of agency mortgage-backed securities and about $175 billion of agency debt. The amount of agency debt purchases, while somewhat less than the previously announced maximum of $200 billion, is consistent with the recent path of purchases and reflects the limited availability of agency debt. In order to promote a smooth transition in markets, the Committee will gradually slow the pace of its purchases of both agency debt and agency mortgage-backed securities and anticipates that these transactions will be executed by the end of the first quarter of 2010.

Off the top of my head
The economy is in the "sweet spot" for the next 3 to 6 months-- economic activities continue to improve while monetary policies continue to be very accomodating. Cheap money is always welcomed. Stock market and bond market should be able to benefit from liquidity and subdued inflation and inflation expectations. New highs can be made. Low interest rates should continue to lead to weak US dollar. In the immediate short term, however, I would be cautious about 3-5% pullbacks of the stock market (e.g.Dow getting  to aroung 9650) as substantial resource slack may shake confidence easily after an extended rally.

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