The Federal Reserve Board is holding its federal funds rate range at zero to 0.25 percent and promised to use “all available tools to promote economic recovery and preserve price stability.” The governors unanimously reiterated their pledge to buy as much as $1.25 trillion of agency mortgage-backed securities and $200 billion of agency debt by the end of 2009, and its plan to scoop up $300 billion of Treasuries by the fall.

The Fed “emphasized it would remain flexible, adjusting its purchases of mortgage-related and Treasury securities as incoming evidence suggest,” according to Sherry Cooper, executive vice president and global economic strategist, BMO Financial Group and chief economist at BMO Capital Markets. 

“It’s likely that if the Fed errs, it will be on the side of too much easing rather than too little,” she writes in a research note, adding that it “sees little risk of overdoing it in the current environment and still meaningful danger of continued constrained credit flows and weak demand.” The Fed avoided mention of the swine flu and the “pandemic risk and the actions already taken that disrupt travel and trade, these developments also put downside risk on a fragile global economy,” Cooper notes. “Uncertainty and fear is the last thing the economy needs.”

There are signs that some calmness has returned to the financial market, though the word “recovery” probably overstates the situation, observers caution. The LIBOR-OIS spread narrowed to a seven-month, moving back to its level just before the Lehman failure, notes CreditSights in its May 1 morning comment. Borrowing in the Fed’s Commercial Paper Funding Facility dropped more than 25 percent after treading water for weeks. Nobody showed up for the $25-billion Term Securities Lending Facility auction on April 30; the TSLF auctions have been undersubscribed for months.

All well and good, but the Fed’s balance sheet is showing the wear and tear of its remarkable (and successful, to date) efforts to keep the wheels of finance rolling—a $130 billion hit last week alone, the “largest negative shift in both absolute and percentage terms” since the beginning of the credit crisis in the second quarter of 2007. And CreditSights notes that “in its quarterly refunding statement the Treasury detailed a range of initiatives and changes to the quarterly refunding schedule to help it address the record $361 billion of marketable debt that it estimates it will need to borrow” in the second quarter alone. Just wait until the Obama stimulus and first budget kick in.

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