Two Subtle, Significant Changes To The Fed Statement

There were two subtle but significant changes to today’s Fed statement (FOMC Statement Sept 23) compared to the one from August 12:

(1) Upgrade Of The Economy –

The Fed now says that “economic activity has picked up following its severe downturn”.  That compares with “economic activity is leveling out” (Aug 12) and “the pace of economic contraction is slowing” (June 24).

(2) Very Gradual Phasing Out Of Mortgage Securities Purchases –

Today’s Fed comment on its purchase of Fannie and Freddie mortgage backed securities and debt reads: “The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010.”

Previously these purchases were to be completed “by the end of the year”.  So this is a subtle but important change.  The Fed is not extending or expanding its purchase of Fannie and Freddie mortgage backed securities and debt but slowing down the purchases by spreading them out over a longer period of time as it phases out the program. 

This is the first inklings of an exit strategy…..

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Can the housing and mortgage markets function without the Fed purchasing substantially all of Fannie and Freddie’s mortgages?  If the Fed doesn’t buy them, who will?  If demand is weak that means lower prices for these mortgages which means higher interest rates which would be a negative for the housing market.

Can the economy and market continue to recover and expand without all the government stimulus?  Are the Feds in danger of repeating the mistakes of 1937?  On the other hand, can the dollar and Treasury market withstand years more of this level of money printing and deficit spending?

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Market reaction seemed to absorb this subtle weakening of the fruit punch.