Fed Officials Stand Pat But Ready To Act If Needed

The Federal Reserve on Wednesday offered a gloomier view of the economy as the labor market showed no sign of improvement since its last meeting. However, despite mounting signs of a sharp slowdown in the U.S. economy, central bank officials decided to take more time to make up their mind and refrained from enacting another monetary stimulus.

In a statement after a two-day meeting, the Fed's policy setting panel reiterated that it will keep interest rates at 0 percent to 0.25 percent and does not expect the federal funds rate to rise until late 2014 at the earliest.

At its June Federal Open Market Committee meeting, policy makers basically left all measures unchanged and only slightly changed the wording about the economy, which has happened many times in the past.

The Fed described the economy as "decelerated somewhat over the first half of this year," versus "expanding moderately" in the June statement.

Central bankers admitted that growth in employment "has been slow in recent months" and that unemployment rate "remains elevated." In June it had said growth in employment "has slowed in recent months."

At its June 19-20 policy meeting, the Fed signaled it was at least considering new stimulus when it said it was "prepared to take further action as appropriate" to support the economic recovery.

This time around, the Fed said it "will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed" to support the economic recovery.

Policymakers nodded to "some further signs of improvement" in the housing sector, and, while repeating that they expect moderate economic growth in coming quarters, said the recovery should then "pick up very gradually."

Growth of business investment has continued to advance. But household spending "has been rising at a somewhat slower pace than earlier in the year." In June, the Fed said household spending "appears" to be rising at a somewhat slower pace than earlier in the year.

These changes in wording could suggest the Fed is closer to launching new programs, possibly a third round of quantitative easing, or QE3.

Judging from the limited information in the statement, the Fed is waiting for more evidence, particularly from the jobs market, before it makes a new move. Market participants expect the central bank to unleash QE3 at its September FOMC meeting.

"We see the September meeting, which comes after the release of two more payroll reports and includes a press conference and a new set of FOMC projections, as a more likely near-term decision point," Michael Gapen, senior US economist at Barclays, wrote in a July 27 note to clients.

"One factor behind our view is the state of financial market conditions, which have not worsened to the same degree they had prior to previous Fed asset purchase programs," Gapen said. "Also, while capital markets were the main source of financing for corporations in 2009 and 2010, bank lending to the nonfinancial corporate sector began to grow on a net basis beginning in 2011 and has continued to expand in recent months."

In terms of risks, Wednesday's statement reiterated that "strains in global financial markets continue to pose significant downside risks to the economic outlook."

Meanwhile, the committee continues to anticipate that "inflation over the medium term will run at or below the rate that it judges most consistent with its dual mandate."

The statement was approved on an 11 to 1. Richmond Fed President Jeffrey Lacker, who is known for his hawkish stance on inflation, dissented for the fifth straight meeting. The statement said Lacker "preferred to omit the description of the time period over which economic conditions are likely to warrant an exceptionally low level of the federal funds rate."

Equity markets dropped sharply a few minutes before the release of the note -- suggesting at least some traders believed they could front-run the Fed or bull scare the market -- but quickly recovered.

The benchmark S&P 500 Index, which had been trading near 1,380 points in mid-afternoon New York action, fell by nearly half a percentage point between 2:12 and 2:15. But 15 minutes after the central bank's press release went public, it had rallied back to recoup most of those losses.

A similar, but even more pronounced, dynamic took place in the government bond markets. Between 2:13 and 2:14, bears and bulls battled it out, sending the yield on the benchmark ten-year U.S. government bond into a wild drop to 1.476 percent. But the drop was reversed, and then some, with yields recently quoting at 1.519 percent

Since the Fed's last meeting in late June, a stream of soft economic reports has suggested the economic recovery is losing steam.

Employers added only an average of 75,000 jobs in the April to June period. That's down from 226,000 in the first quarter and the weakest in almost two years, Labor Department figures show.

Payrolls are estimated to have climbed in July by 100,000, slightly higher than the 80,000 jobs created in June, according to the median forecast of economists surveyed by Reuters ahead of Labor Department figures due on Aug. 3.

The unemployment rate, which has exceeded 8 percent since February 2009, will likely hold steady at 8.2 percent in July, economists say.

And that figure isn't coming down any time soon -- not as long as the economy grows as slowly as it did in the second quarter.

U.S. gross domestic product grew at a 1.5 percent annual rate in the second quarter after posting an average growth of 3 percent over the prior two quarters, the Commerce Department said on July 27.

Moreover, American consumers cut back sharply on spending in recent months. Household purchases, which account for about 70 percent of GDP, also grew 1.5 percent, the slowest pace in a year and down from a 2.4 percent advance from January to March.

Wednesday's Fed statement will likely be a prelude to what the European Central Bank does Thursday at its monthly policy meeting. When ECB chief Mario Draghi vowed last Thursday that he was ready to "do whatever it takes" to save the euro, he fueled investor hopes that the central bank would again start buying government bonds to lower borrowing costs for struggling countries.