Don't forget the Fed
The central bank's latest meeting likely won't have much in the way of fireworks. But even though the Fed may not do much, pay attention to what it says.
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| Long-term rates are still relatively low. But the yield on the 10-Year Treasury has crept back up towards 3% in recent weeks. |
NEW YORK (CNNMoney.com) -- If the Federal Reserve holds a policy meeting but the market isn't interested, will chairman Ben Bernanke still make a sound?
The Fed's Open Market Committee, the body that sets short-term interest rates, is meeting Tuesday and Wednesday. But what would normally be a big news event for investors is being overshadowed by a litany of other developments.
There's the latest restructuring moves by General Motors (GM, Fortune 500) and Chrysler LLC as they attempt to avoid bankruptcy, continued questions about the big bank stress tests, and the upcoming 100-day milestone for the Obama administration.
If all that wasn't enough, there are worries about a swine flu epidemic.
It makes sense that the Fed isn't getting all the attention. Come Wednesday, the Fed is likely to simply leave short-term interest rates near zero, as it has done since December.
What's more, it's going to be hard to top the news from the Fed's last meeting in March. That's when the central bank finally announced it would start buying long-term U.S. Treasurys, a move that many investors had been expecting for months.
That decision helped keep a floor on mortgage rates and spur a mini refinancing boom, which is one reason why many banks were able to report better first-quarter results than expected.
That comes on top of all the other Fed actions of the past few months to try and encourage lending, such as programs to buy short-term loans for businesses known as commercial paper as well as various asset-backed securities.
With all that in mind, don't expect any significant announcements on Wednesday.
"The Fed has gotten a lot of stuff right and it is worth continuing to watch them," said Fred Fraenkel, chairman of investments at Beacon Trust Company, a Summit, N.J.-based money management firm. "But there are not many more amazing things left that it can do. It already has come up with a lot of policies that have gotten traction and pulled us out of the depths of potential depression and deflation."
Still, investors shouldn't completely ignore what the Fed has to say on Wednesday. Stocks have staged an impressive rally since early-March. And you can make a case that confident talk from the Fed has helped fuel it.
Bernanke appeared on "60 Minutes" on March 15 and talked about detecting some "green shoots" of economic recovery. He's reiterated several times since then that the economy, while certainly still in perilous shape, has the potential to start rebounding later this year.
In light of this, it's possible that the Fed could acknowledge the market's rally on Wednesday as an encouraging sign.
In a note to clients Monday, Ashraf Laidi, chief market strategist with currency brokerage CMC Markets, suggested that the Fed might make "a discreet reference" to improving market and economic dynamics. He wrote that the Fed could talk about a "slowing pace of decline" or "tentative signs of stability," for example.
Any comments along those lines could further spur investors' appetite for risk and keep the market rally going.
It's also worth pointing out that the Fed's announcement will come several hours after the government releases its first report about gross domestic product in the first quarter.
Economists are forecasting a 4.9% decrease in economic activity from a year ago. And while that's still evidence of an economy in the midst of a severe recession, it is a lower rate of decline than the 6.3% drop in the fourth quarter of 2008. So if GDP doesn't wind up plunging sharply more than anticipated, the Fed might note this as another small step toward stabilization.
"The Fed might be sensing more signs that the intensity of the recession is lessening. It could hint at pockets of improvement for the short-term," said Michael Strauss, chief economist with Commonfund, a money management firm based in Wilton, Conn.
However, Strauss added that the Fed might soon look to comment more on the fact that its balance sheet has expanded rapidly due to the cost of funding its various liquidity programs.
Some critics of the Fed maintain that it is simply printing money without regard for future inflation risks. But Fed members, particularly Bernanke, have been quick to counter that they can easily and quickly unwind many of these programs and shrink the balance sheet by raising interest rates.
But Laidi added that he doubted the Fed would go so far to hint that any interest rate hikes are in the cards just yet since there are few signs of inflation on the immediate horizon.
So he thinks the Fed is also likely to reiterate that "economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period."
Keeping that language could also be a way for the Fed to try and rein in long-term interest rates, which have been rising steadily during the past few weeks despite the Fed's purchases.
Prices on the 10-year Treasury have fallen, pushing the yield back around 3% for the first time since mid-March. Bond prices and yields move in opposite directions. Rising long-term rates could be a concern since it would offset the Fed's moves to try and maintain relatively low rates for mortgages.
So the Fed, as usual, appears to be in a bind. It's going to want to give further credence to the notion that the worst may be over.
But if its tone is too optimistic, it risks sparking another sell-off in bonds and a spike in long-term rates, which could do more harm than good for an economy that's still fragile at best.
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