The Fed is due to end purchases of mortgage backed securities by the end of March. That will leave it with $1.25T worth of mortgage backed bonds. This extraordinary measure was taken to ensure mortgage rates remain low in order to make home purchasing easier (so we could reduce a mountain of housing inventory). We’ll see where mortgage rates go once the Fed stops supporting the housing industry with its balance sheet. (I wonder how the Fed unloads $1.25T worth of mortgage-backed debt. We’ll keep a close eye on our GNMA fund in case it is side-swiped from sales of Fanny & Freddie debt.)

In early February, the Fed began reducing other extraordinary / emergency facilities it made available to US banks during the banking crisis. It is also considering when it will raise short term interest rates. They’d prefer to continue cutting interest rates to stimulate economic growth, but since short term interest rates are near zero, there’s not much they can do. The Fed is also now painfully aware that when interest rates are kept artificially low for a prolonged period, asset bubbles occur in housing & stock markets.

But we’re not the only ones with the challenge of removing federal government economic support. Virtually all economies opened their federal purses and spent in order to prevent an economic depression. But look at the list above. The countries near the top will have the easiest time reducing their federal government economic steroids. In fact, China, Brazil, Norway and Australia have already implemented several measures to allow their government spending to be slowed or shut off. Canada’s central bank keeps hinting at raising interest rates.

On February 18th, the Fed surprised many by announcing it would raise the discount rate by 0.25% to 0.75%. I would not call it a non-event, but neither does it represent much in the way of a monetary policy change. Don’t confuse the Fed’s actions to increase the discount rate with raising the fed funds rate. The discount rate is charged by the fed to commercial banks for last resort overnight lending needs. It is meant to be a punitive safety net. The Fed needed to raise the discount rate -and needs to raise it further. Prior to the banking crisis, the discount rate was over 6%. This represented a rate 1% higher than the Fed Funds rate. The low interest rates were to help banks survive the banking crisis. If the Fed is beginning to raise the discount rate, it means the Fed believes large banks are now strong enough to raise money on their own at market rates if they need to. This should be interpreted as an endorsement for the soundness of the US banking system. The banks have had ideal conditions with which to earn profits & rebuild their balance sheets over the past 1.5 years. And to be fair, a 0.75% Fed discount rate is still helpful to banks.

The Fed Funds rate is the key short term lending rate that banks charge each other for overnight loans. This rate matters much more in terms of defining short term interest rates for our economy. This rate remains targeted at 0 to 0.25% – extremely loose/accommodative monetary policy (assists in economic growth).

Why keep short term interest rates at historic lows? Answer: the economy remains very weak. February 19th saw the release of January’s inflation data. For the first time in 28 years, the core inflation rate in our economy was negative. That means overall pricing of goods & services (without the volatile short term impact of food & energy) went down. That is deflation by definition. Deflation is highly corrosive to economies. It is combated with free money (low interest rates) and with tax cuts – if you can afford it. We can’t –since we’re already digging the mother of all holes with our current budget deficit. Reducing taxes would simply make the hole bigger because spending will be cut much slower/smaller than taxes.

February 23rd saw the release of The Conference Board’s most recent consumer poll. Consumer sentiment from the measure called ” Present Situation Index” plummeted to the lowest level since 1983. It is no coincidence that low consumer sentiment and deflation are arriving in tandem.