Fed To Remain OA

In order to prevent the U.S economic recovery from being squashed, the Federal Reserve's monetary policy is expected to retain its overly accommodative (OA) stance for an extended period.

So far, the Fed has reduced interest rates to almost zero and pledged to buy up to nearly $1.8 trillion worth of U.S. government and mortgage debt in order to combat a severe recession. This has been an attempt to prevent the economy from slipping into deflation, similar to what occurred in Japan when that country endured a decade of stagnation during the 1990s.

However, the St. Louis Federal Reserve Bank's President James Bullard has pointed out that having a withdrawal plan of the massive expansion of the U.S. monetary base is just as important. Without an exit strategy, expectations of high inflation may develop and feed into today's long-term yields. Therefore, financial institutions such as but not limited to Citigroup (C - Analyst Report), Bank of America (BAC - Analyst Report), Wells Fargo (WFC - Analyst Report), JPMorgan (JPM - Analyst Report) and US Bancorp (USB - Analyst Report) have increased their respective 30-year mortgage rates by 100 bp within the past 45 days. The result yields could continue to rise and thereby hamper recovery prospects.

The Fed may take several options to reduce its balance sheet to tighten policy. While issuing Treasury supplementary financing programs or the issuance of Fed debt may be unlikely choices given the size of the U.S. budget deficit, repurchase programs and the payment by the Fed of interest on reserves have been untested within the current context of what the U.S. central bank now is up against. The most likely avenue would be the selling of Fed-owned assets.

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