Publish date:

Fed Keeps Rates Near Zero

The Federal Open Market Committee kept its interest rate target between zero and 0.25%, as expected, at the conclusion of its two-day meeting.

(Update includes stock market reversal)



) -- The

Federal Reserve

made the widely anticipated declaration on Wednesday that it will continue its cheap-money policy that has helped spur an economic recovery, while weighing on the dollar.

The policy-making Federal Open Market Committee said at the close of its two-day meeting that it will hold its key interest-rate target at a level of zero to 0.25%. The unanimous decision comes as no surprise, and the U.S. central bank reiterated its pledge to keep rates "exceptionally low" for an "extended period" of time.

"The committee ... continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period," the Fed said in a statement.

The key change in the Fed's language is an indication that rates will not change until some slack is picked up in the economy -- through borrowing, spending, production and the like -- to move inflation and market expectations higher. But the Fed also repeated its assertion that inflation is likely to "remain subdued for some time."


Dow Jones Industrial Average

initially surged more than 150 points after the decision, but later reversed. Recently, the average was trading up 23 points to 9795.

The central bank has pumped more than $1 trillion worth of money into the markets through low interest rates, collateral-based lending programs and other means, and must extract those funds before inflation begins to roar. Some of those programs have already petered out or been scaled back as the private market has strengthened.

Last week, the Fed announced that over the next several weeks, it will halt its unusual tactic of buying $300 billion worth of Treasury bonds as well. Its program to buy $1.25 trillion worth of mortgage-backed securities is expected to continue through March.

"The best way for the Federal Reserve to smoothly exit from its current stance on monetary policy is to make it more a process than an event," says Anthony Crescenzi, a strategist at Allianz's behemoth bond shop, Pimco. "This approach has worked thus far."

On Wednesday, the Fed indicated it will "continue to employ a wide range of tools to promote economic recovery and to preserve price stability," as it has for some time.

But once those programs have ended, banks will still have too much money in reserve, and the Fed will still have a huge balance sheet saddled with over $2 trillion in Treasury bonds, MBS, debt issued by

Fannie Mae



Freddie Mac


and Ginnie Mae, as well as toxic debt from the government-supported rescues of

Bear Stearns


American International Group

TheStreet Recommends

(AIG) - Get American International Group, Inc. Report

. The Fed plans to resolve this imbalance in part through more transactions with banks called reverse repo agreements. In those,

primary dealers lend money to the Fed in exchange for collateral, which is temporarily placed on their balance sheets.

The Fed recently tested this strategy in the market, and has indicated that a combination of reverse repos and gradually higher interest rates will put the economy back on an even keel without fueling higher prices.

Many economists believe the Fed will begin raising rates in mid- to late-2010, once it has begun the liquidity drain. In the meantime there will be opportunities for investors in the Forex, commodities and fixed income markets. Big banks like

Goldman Sachs

(GS) - Get Goldman Sachs Group, Inc. (GS) Report


JPMorgan Chase

(JPM) - Get JPMorgan Chase & Co. (JPM) Report


Bank of America

(BAC) - Get Bank of America Corp Report


Wells Fargo

(WFC) - Get Wells Fargo & Company Report



(C) - Get Citigroup Inc. Report


Morgan Stanley

(MS) - Get Morgan Stanley (MS) Report

have leveraged trading in those areas to boost capital-markets businesses or hedge their interest-rate sensitive mortgage-servicing portfolios.

Investors were sending the dollar lower and commodities higher on Wednesday morning, as gold reached a record spot price of $1,090.62 per troy ounce and oil topped $80 a barrel. The ICE Futures U.S. dollar index, which measures the dollar against six currencies fell 0.5%, with the euro buying $1.4781 and the British pound buying $1.6528. The Dow Jones Industrial Average was up 1.4% at 9,908.09 while Treasurys were losing ground, with the 10-year note yielding 3.49%, and the two-year note yielding 0.94%.

-- Written by Lauren Tara LaCapra in New York