Fed to Buy Up Treasuries; Rates Stay Put
The Federal Reserve could end up regretting its latest quantitative easing move, according to a former Fed economist.
"From my point of view, the Fed will ultimately look back at this decision with some regret because it will pull them away from renormalizing monetary policy," said Gregory D. Hess, faculty dean at Claremont McKenna College. "This further distorts asset prices like Treasury bonds and makes it more difficult for the market to recalibrate risk in a global environment, which is what's needed for the economy to get to a position where it can grow robustly on a consistent basis."
The Federal Open Market Committee announced Wednesday that it will buy $600 billion of longer-term Treasury securities by the end of the second quarter of 2011 at a pace of about $75 billion per month, with the objective of lowering long-term interest rates and helping support the economy.
Hess said Treasuries hardly moved on that news, suggesting that a purchase of this size was already priced into the market. Hess also said that the Fed's mortgage-backed securities purchases are running off faster than expected, so reinvestments would likely push the Fed's purchases closer to $900 billion.
"The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability," said the FOMC in the
issued at the conclusion of its two-day monetary policy meeting.
The second round of quantitative easing, dubbed QE2, largely met
expectations in both its timing and scope, although market strategists differ in their opinions of how effective the measure will be at bolstering the flagging recovery. Critics assert that further stimulus could create dangerous asset inflation. The Fed's hope is that a temporary lowering of long-term interest rates will drive investors to riskier assets, stimulating investment and spending.
Estimates ranged from $50 billion to $100 billion in monthly purchases over several months from those who anticipated an open-ended approach, while those projecting a more significant injection from the Fed forecast between $500 billion and $1 trillion through the end of 2011.
As expected, the FOMC voted to keep the target fed funds rate unchanged at the zero to 0.25% level and said information received since its September meeting suggests a slow pace of recovery. The Fed acknowledged mild improvements in consumer and business spending as it expressed disappointment in sluggish job growth and the weak housing market.
The FOMC also maintained language suggesting that economic conditions would continue to "warrant exceptionally low levels for the federal funds rate for an extended period."
Stressing its dual mandate to foster employment and price stability, the Fed's policy-setting arm said it would expand its securities holdings by reinvesting principal payments from its holdings and enact additional purchases to "promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate."
Expectations for QE2 have been running high since late August when the central bank first said it would be willing to purchase long-term assets as a way to keep the recovery on track. Since then, stocks have climbed, and the S&P is up roughly 14%, while the value of the dollar has slumped.
Immediately following the news, stocks pared losses and since turned positive. The major U.S. indices finished the session roughly 0.3% higher. The dollar traded lower against a basket of currencies, with the dollar index down by 0.3%. The benchmark 10-year Treasury note strengthened 5/32, diluting the yield to 2.576% and the 30-year Treasury bond fell 2 6/32, strengthening the yield to 4.061%.
In late 2008, the central bank purchased $1.7 billion of Treasury bonds and mortgage-backed securities in response to the economic crisis -- a difficult decision that the Fed, as the lender of last resort, made to extinguish fires raging throughout the economy, Hess said.
Although the Fed had hoped to begin exiting easing measures by now, continued subdued inflation pressures and a stubbornly high unemployment rate of 9.6% prompted it to consider other options since it has already kept key interest rates near zero since Dec. 16, 2008.
"In my mind, the Fed hasn't made a good case for why its concern for deflation is warranted and why these additional actions need to be taken to support the economy," Hess said.
Looking ahead, Hess believes the the Republican takeover of the House in mid-term elections will likely result in compromises on tax rates, which could increase certainty and encourage businesses to hire more people.
"I think that's what we should be focusing on to support economic growth rather than risky Fed policy decisions," he said.
Kansas City Fed President Thomas Hoenig was again the only member to vote against the policy, objecting that the risks of buying more securities outweighs the benefits.
According to the statement, Hoenig also worried that additional easing measures "increased the risks of future imbalances and, over time, would cause an increase in long-term inflation expectations that could destabilize the economy."
--Written by Melinda Peer in New York
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