It looks like the Fed's a little worried over the outlook for the US economy. Then again, who wouldn't be? Production and employment have weakened in recent months, loans are hard to come by, and the housing market is still in a slump. Sounds like a headache to me!
And how does the Fed plan to respond to all this? Well you can bet they won't be sitting on their hands!
According to Fed Chairman Ben Bernanke, they are ready and willing to do all they can to combat the country's economic problems and stimulate growth. Their first step was to keep interest rates locked at 0.25%, where it will probably stay until the economy shows a bit more stability. Secondly, the Fed has plans to start reinvesting principal payments of mortgage back securities and agency debt.
You're probably thinking, "Uh... What does 'reinvesting principal payments of mortgage back securities and agency debt' mean?"
Lemme explain all this gibberish to you. Instead of chillin' out once the original securities mature, the Fed will now be investing in longer-term Treasury securities. By reinvesting the principal payments of assets that they bought in the past, the Fed has effectively chosen to maintain the current level of quantitative easing measures. In a way, they are just "recycling" previous measures, in order to keep the economy afloat.
This sends a strong message that Bernanke and his boys will do whatever it takes to spruce up the economy. More importantly, these moves express openness to further quantitative easing down the road.
So how did the markets react to the sudden turn in sentiment by the Fed? After all, they sounded pretty optimistic just a couple months ago!
Within minutes of the Fed's announcement, the dollar was sold off like ice cream on a hot summer day. It melted across the board and gave as much as 100 pips to the euro and 200 pips to the pound.
Could this be the beginning of the end for the dollar?
It's too early to tell. Remember, talk of the Fed engaging in another round of quantitative easing is not something new, which means that investors and traders may have already priced in their expectations. The dollar's immediate losses yesterday were much less severe than in 2009 when the Fed first implemented its quantitative easing program.
While the trend is not the dollar's friend, the prospect of traders falling back into risk aversion mode is still there. Most major economies remain at risk of falling back into recession, so let's wait for confirmation moves before betting the ice cream truck!