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The U.S. Federal Reserve decided on Tuesday to lower its Fed Funds rate by 75 basis points to 0.25 percent, the lowest level for the overnight rate ever. In particular, the Fed is concerned about the deterioration in the labor market, tight credit conditions and the ongoing contraction in the housing market which is likely to weigh on economic growth over the next few quarters. More importantly, the Fed anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time, according to the Federal Open Market Committee (FOMC) statement released today.

Market Reaction

The U.S. dollar, which had been lower ahead of today’s Fed rate decision, fell even further against the world’s most heavily traded currencies. However, the currency market remains very volatile and is still too early to make any type of cause-effect extrapolation between the recent price action and today’s Fed rate decision. The key question for the U.S. dollar is whether the U.S. economy will continue to grow in face of job losses and a massive deleveraging in the financial sector.

source: bloomberg

Next Stop! Zero Interest Rates

The next FOMC meeting is on January 28 and the Fed looks poised to cut rates all the way to zero, according to the implied probability on Fed Funds futures.

 source: bloomberg

Federal Open Market Committee (FOMC) Statement

"The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to 1/4 percent.

Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined.  Financial markets remain quite strained and credit conditions tight.  Overall, the outlook for economic activity has weakened further.

Meanwhile, inflationary pressures have diminished appreciably.  In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate further in coming quarters.

The Federal Reserve will employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.  In particular, the Committee anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.

The focus of the Committee's policy going forward will be to support the functioning of financial markets and stimulate the economy through open market operations and other measures that sustain the size of the Federal Reserve's balance sheet at a high level.  As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant.  The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities.  Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses.  The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Christine M. Cumming; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 1/2 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Cleveland, Richmond, Atlanta, Minneapolis, and San Francisco.  The Board also established interest rates on required and excess reserve balances of 1/4 percent. "

source:  http://www.federalreserve.gov

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Written by Antonio Sousa, Chief Strategist for DailyFX.com
To contact the author of this report, e-mail asousa@fxcm.com

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