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Fed Launches Open-Ended QE3; Wall Street Goes Wild

Updated from 3:05 p.m. ET to include closing stock market prices.

NEW YORK ( TheStreet) -- The Federal Reserve opted for an aggressive monetary policy action Wednesday, announcing an open-ended asset purchase program to buy $40 billion worth of mortgage-backed securities per month and extending its pledge to keep interest rates at current historic lows until at least mid-2015.

"The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," read the statement of the Federal Open Market Committee, which comes at the end of the central bank's September policy meeting.

The Fed will also continue Operation Twist, which calls for it to buy long-term bonds as its short-term holdings mature, through the end of 2012.

Eleven of the 12 members of the Fed's open market committee voted in favor of the policy action with Jeffery Lacker, president of the Federal Reserve Bank of Richmond, serving as the lone dissenter.

"These actions, which together will increase the Committee's holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative," the statement said.

The Fed has kept its interest rate target at the current zero level since December 2008. This new program puts the central bank on the hook for asset purchases of nearly $300 billion through the end of 2012 with September's buying of mortgage-backed securities expected to total $23 billion.

Wall Street was euphoric following the decision. The Dow Jones Industrial Average soared more than 206 points, or 1.53%, to close at 13,540.

The S&P 500 advanced more than 23 points, or 1.63%, finish at 1460, and the Nasdaq jumped more than 41 points, or 1.33%, to settle at 3156.

As for what the Fed does next, the statement said the central bank plans to maintain its "highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens."

Thursday's move was driven by the stagnant conditions in the labor market. The Fed's dual mandate calls for maximum employment and keeping a lid on inflation. While prices have been relatively stable, the unemployment remains above 8% and job creation has been inconsistent with August non-farm payrolls increasing by just 96,000. The Fed indicated its bond buying would likely continue until the employment picture brightens.

"If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability," the statement said. "In determining the size, pace, and composition of its asset purchases, the Committee will, as always, take appropriate account of the likely efficacy and costs of such purchases."

Fed Chairman Ben Bernanke defended the aggressive action in a press conference shortly after the decision was announced, saying "We want unemployment to come down in a sustained way."

Paul Ashworth, chief U.S. economist at Capital Economics, said the per month purchasing of $40 billion worth of mortgage-backed securities was smaller than expected and he thinks the pressure to up the ante could soon start to mount.

"Overall, the Fed has done all the markets were asking for," Ashworth wrote in emailed commentary. "The problem is that we doubt it will be enough to get the economy on the right track. It's only a matter of time before speculation begins as to when the Fed will raise its purchases from $40bn a month."

RDQ Economics said the action would likely give stocks a temporary boost and expressed some concern about the unintended consequences that could result.

"Our view is that these actions will do little to stimulate growth but will raise inflation expectations (dollar negative and gold and commodity positive)," the firm said. "As for other markets, we think that risk assets will get a short-term sugar rush, which will further support equity prices. What about yields, however, which the Fed is seeking to lower? Our guess is that to the extent the Fed boosts the demand for risk assets, yields will drift higher (as was the experience following the announcement of QE2). Bernanke is marching U.S. monetary policy even further into totally uncharted territory."

In its release of economic projections, the Fed lowered its view for the change in real GDP in 2012 to 1.7%-2% from a June estimate for growth of 1.9%-2.4% but boosted expectations for 2013 and 2014 to 2.5%-3% and 3%-3.8% respectively from prior projections for growth of 2.2%-2.8% and 3$-3.5%.

The central bank is now targeting a reduction in the unemployment rate to a range of 6.7%-7.3% in 2014, a slight reduction from June's projection of 7%-7.7%.

"The message from their numbers is that, assuming inflation is not at issue, they will not tighten until the unemployment rate is at least below 7%," said Jim O'Sullivan, chief U.S. economist at High Frequency Economics.

Of the press conference, O'Sullivan observed: "In justifying today's actions, Mr. Bernanke once again expressed his 'grave concern' with the 'employment situation.' He also suggested that the QE program could be expanded to include Treasuries as well as MBS after Operation Twist concludes at year-end--if the outlook for the labor market does not improve substantially."

-- Written by Michael Baron in New York.



>To contact the writer of this article, click here: Michael Baron.

Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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