Fed Moves to Push Down Long-Term Rates

In extending its campaign of novel efforts to shake the economy from its torpor, the Fed said that it was responding to evidence that there was a clear need for help.

“Growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions and the unemployment rate remains elevated,” the Fed said in a statement that listed its reasons for worry about the anemic condition of the American economy. “Household spending has been increasing at only a modest pace in recent months.”

The central bank said in a statement that the program was aimed at reducing the cost of borrowing for businesses and consumers, including the cost of mortgage loans. It hopes that the lower rates will encourage companies to build new factories and hire more workers, and consumers to start spending again on homes and cars and clothes and vacations.

Specifically, the Fed said that by June 2012 it would sell $400 billion in Treasury securities with remaining maturities of less than three years and purchase roughly the same amount of securities with maturities longer than six years. It said the result would move the average maturity of the bonds it holds to about 100 months from 75 months.

In the bond market Wednesday, the yield on 10-year Treasury notes did indeed fall after the announcement, to 1.88 percent from 1.94 percent, while the 30-year bond yield dropped to 3.02 percent from 3.20 percent. Stocks on Wall Street were down about 1.7 percent in afternoon trading.

Separately, the Fed said it would resume direct efforts to help the mortgage market by reinvesting the proceeds of its existing investments in mortgage-backed securities into new mortgage-backed securities, rather than putting the money in Treasuries.

Three members of the Fed’s 10-member policy-making committee dissented from the decision: Richard Fisher, president of the Federal Reserve Bank of Dallas; Charles Plosser, president of the Federal Reserve Bank of Philadelphia; and Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis. The members were the same who opposed the Fed plan announced in August to hold short-term interest rates near zero until at least 2013.

The new effort is an experiment without a direct precedent, although the Fed tried something similar in the 1960s. Essentially, by shifting its money into riskier investments, the Fed hopes to drive down rates without expanding the size of its portfolio, as it has done twice in recent years. By reducing the supply of long-term Treasuries, the Fed intends to force investors to accept lower rates of return on a wide range of riskier investments.

Economists project that the effort could reduce interest rates by a few tenths of a percentage point, a significant increment when multiplied by the vast extent of borrowing. The forecasting firm Macroeconomic Advisers estimated in advance of the Fed’s announcement — based on its best guess about the details of such a program — that the Fed’s efforts could add about 0.4 percentage points to economic output and create about 350,000 jobs.

The Fed already is engaged in an enormous effort to stimulate growth. The central bank has held short-term interest rates near zero since December 2008. To further reduce long-term rates, it has amassed more than $2 trillion in government debt and mortgage-backed securities. And the Fed announced after the most recent meeting of its policy-making committee in August that it intended to hold short-term interest rates near zero until at least the middle of 2013.

The Fed had previously said only that it would maintain rates near zero for an “extended period,” and a new study by the Federal Reserve Bank of Cleveland found that the change in language had a significant impact. Specifically, by convincing investors that short-term rates would remain low, the Fed succeeded in lowering long-term rates — which are based in large part on expectations about the level of short-term rates throughout the longer period. Rates on the benchmark 10-year Treasury note, for example, declined by about 0.20 percentage points, the study found.

Article source: http://www.nytimes.com/2011/09/22/business/fed-to-shift-400-billion-in-holdings-to-spur-growth.html?partner=rss&emc=rss