In efforts to fulfill the Federal Reserve's two primary goals, maximum employment and price stability, the Federal Reserve announced asset purchasing actions following its September 12-13 FOMC meeting.
The new actions will add mortgage-backed securities purchases to its current maturity extension program in an effort to encourage further housing market growth. The FOMC also stated it would keep the federal funds target rate at 0.00 to 0.25 percent through mid-2015.
The Federal Reserve's decision to increase purchases of mortgage-backed securities by $40 billion per month is intended to create greater demand for mortgage lending and home buying. The mortgage-backed securities purchases are intended to decrease rates further, causing increased demand for mortgage lending and home buying. These effects are expected to fuel housing prices, sales and construction.
Housing prices have been steadily increasing. According to quarterly averages for Freddie Mac's House Price Index, housing prices for single-family and townhouses increased by a growth rate of 4.8 percent in the second quarter. Index data for S&P/Case-Shiller's Home Price Index also showed a second quarter increase of 6.9 percent. Increased demand for mortgages and home purchases resulting from the Federal Reserve's new MBS actions are expected to help improve housing price appreciation.
Housing sales have also shown strong improvement in the past year, increasing from an annual rate of 4.48 million at the end of Q2 2011 to 4.90 million at the end of Q2 2012. According to Freddie Mac's September 2012 U.S. Economic and Housing Market Outlook, this rate is expected to continue increasing with a projected rate of 5.20 million at the end of Q2 2013. Given the expected effects of the Federal Reserve's MBS actions, this rate could show even greater improvements which could further increase housing construction projections and earnings growth for residential construction companies.
According to Freddie Mac's September Outlook, housing starts have grown from an annual rate of 0.57 million in Q2 2011 to 0.74 million in Q2 2012, with a projected rate of 0.88 million in Q2 2013. Even slight increases in housing demand resulting from the new MBS actions could help further improve housing construction rates.
This is all good news for construction companies focused on residential home building. Stock prices for the three largest construction companies in the S&P 500's Consumer Discretionary sector gained in the day following the FOMC's meeting announcement.
Secondly, the continuation of the Fed's maturity extension program, which sells short-term securities and buys longer-term securities with the goal of keeping longer-term borrowing rates down, will cause a continuation in the current low rate corporate borrowing environment. By instituting further downward pressure on long-term rates, corporate borrowers can receive access to funds for capital expenditures at further reduced rates which increases the likelihood of corporate expansion, leading to more jobs for the labor market and increased productivity for the economy.
Markets reacted positively in the day following the announcement. The Dow Jones Industrial Average was up 0.4 percent, pushing the year-to-date gain to 11.25 percent. The S&P 500 gained 0.4 percent for a year-to-date gain of 16.55 percent. The NASDAQ was also up 0.89 percent, ending the day with a 22.21 percent year-to-date gain.
Additionally, the Federal Reserve's forward guidance on interest rates included no change in the federal funds target rate and projected stabilization at the current rate through mid-2015. By keeping the federal funds rate controlled at 0.00 to 0.25, banks continue to have overnight lending liquidity access at low rates providing greater lending ability.
The Fed's actions alone appear to provide fuel for the U.S. economic recovery, but fiscal uncertainty looms ahead. The Congressional Budget Office stated in an August report that current provisions and policies in effect for January 2012 will increase tax rates and reduce tax credits as well as automatically decrease government spending. The provisions and policy changes scheduled for January 2013 are projected to decrease the deficit to $641 billion for fiscal year 2013, according to the CBO. In its August report, the CBO also stated that the current provisions and policies in effect would likely cause a decline in real GDP of 0.5 percent for the one-year period, from Q4 2012 to Q4 2013. The CBO also projected the productivity decline would lead to a 9 percent unemployment rate in the second half of 2013. These effects could throw the economy off course if no action is taken.
The federal debt ceiling is also a cause of concern for the U.S. economy. The ceiling, which is currently $16.4 trillion, is expected to be reached near the end of the 2012 calendar year, which could cause turmoil for equity markets and slow the growth of the economy.
Chairman Ben Bernanke tirelessly stated in his press conference following the FOMC meeting that the Federal Reserve would do everything in its power to provide support for the economy through the use of its monetary policy tools but that fiscal policy decisions are also an important factor for the economy's growth, and Congress will need to do its part to support the U.S. economy through accommodative fiscal policy decisions as well.
By choosing to implement MBS purchases and continuing Operation Twist on a monthly basis, the Federal Reserve may be able to more closely monitor and adapt to fiscal policy scenarios implemented by Congress, but fiscal policy developments could still drastically alter the Federal Reserve's monetary policy effects. Further, while housing market improvements continue to show positive projections, investors should continue to watch for unexpected increases in mortgage default rates or distressed property levels which could also throw the economy off from its current progression.