Fed Keeps Rates Near Zero

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NEW YORK (TheStreet) -- 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 0% to 0.25%. The decision comes as no surprise since the U.S. central bank had earlier pledged to keep rates "exceptionally low" for an "extended period" of time.

The Fed 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."

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 (Stock Quote: FNM), Freddie Mac (Stock Quote: FRE), Sallie Mae (Stock Quote: SLM) and Ginnie Mae, as well as toxic debt from the government-supported rescues of Bear Stearns and American International Group (Stock Quote: AIG). 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 (Stock Quote: GS), JPMorgan Chase (Stock Quote: JPM), Bank of America (Stock Quote: BAC), Wells Fargo (Stock Quote: WFC), Citigroup and Morgan Stanley 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%.

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