The Fed Statement of August 9, 2011

After yesterday's huge drop in the stock market, the Fed met today and released its statement regarding the economy and its policies going forward.  You can read the transcript here.  It is a short read.

The Fed announced that the current conditions "are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013."  I have written about the federal funds rate before.  The Fed is not really controlling this rate right now, at least through the money supply.  The banks have piled up massive excess reserves and most of them don't need overnight loans.  This has kept the rate near zero.

This statement didn't mean all that much.  If anything, it should really be a bearish sign that the Fed expects to maintain this policy for at least 2 more years.

The transcript does say that the Fed "will maintain its existing policy of reinvesting principal payments from its securities holdings."  This is an indication that they plan to have a stable money policy.  As usual, they leave open the possibility of adjusting their strategy as things progress (or regress).

The market had a slightly negative reaction after this release, but then the stock market exploded in the last hour of trading.  The Dow went up about 600 points in the last hour, closing up more than 400 points for the day.  Of course, this still did not erase all of the losses from yesterday.

Interest rates went down.  It is ironic that rates on government bonds have gone down since being downgraded from AAA status from S&P.  If you want to refinance a mortgage and you procrastinated last year when rates were way down, you have another opportunity.  If you can get a 30 year loan for about 4%, why not take it?  If you stay in your house for a long time, your last payment in 30 years will be practically nothing.  Make inflation your friend, even though it is not.

It is impossible to predict where the market will go from here.  I expect a lot more volatility in the short term.  Ultimately, it is going to depend on government policies and, even more so, Fed policies.  It is important to keep an eye on the adjusted monetary base.  This is far more meaningful than the federal funds rate.  The Fed actually controls the monetary base right now.