Fed to resume buying Treasury bonds
Concerned about a slowing of the economic recovery, the Federal Reserve decided Tuesday to resume buying U.S. Treasury bonds in an effort to hold down longer-term interest rates.
The net effect will be to keep the Fed’s mammoth portfolio of about $2 trillion in U.S. Treasury bonds and mortgage-related securities constant, rather than allow the holdings to shrink as securities are paid off. The Fed bought the bulk of those bonds in 2009 via a program that has helped push mortgage rates to record lows.
Fed policymakers, holding their midsummer meeting, apparently rejected taking more dramatic steps to bolster the economy despite more evidence in recent weeks that growth was ebbing.
But they signaled their unease, saying in their post-meeting statement that the recovery appeared “more modest in the near term than had been anticipated.”
Their decision to buy more bonds had the desired effect in the market, pushing rates on Treasury securities to new lows for the year.
The stock market, which was off sharply before the Fed’s statement, partly rebounded — suggesting that investors were at least relieved that the central bank acknowledged that the economy might need more help.
The Dow industrial average ended the day off 54.50 points, or 0.5%, at 10,644.25 after being down more than 145 points early on.
With Congress increasingly balking at the idea of undertaking huge new stimulus spending programs, there has been more pressure on the Fed to do whatever it can to keep the economy from stalling out.
Analysts called the Fed’s bond-buying commitment a modest move to underpin the economy. Rather than create new money from thin air to buy bonds, as it did in 2009, the Fed said it would use the proceeds from maturing mortgage bonds that it already owns to buy additional Treasury securities.
Christopher Rupkey, an economist at Bank of Tokyo-Mitsubishi in New York, said the Fed’s decision was “a small and largely symbolic step … but it is support for the slowing economic recovery, nevertheless.”
Analysts estimated that the Fed would have between $10 billion and $30 billion a month from mortgage-bond payoffs to use for Treasury purchases. Guy Lebas, a bond strategist at brokerage Janney Montgomery Scott in Philadelphia, said the number could be about $25 billion a month, or $75 billion a quarter.
“It’s real money,” he said.
By comparison, the Treasury’s net borrowing to finance the federal deficit has been running at more than $340 billion a quarter.
Some Fed watchers said the importance of the Fed’s move was that it cemented the view that Chairman Ben S. Bernanke would take whatever steps were necessary to keep the economy from falling back into recession.
Economists at Goldman, Sachs & Co. predict that the Fed may be forced by a weakening economy to buy at least $1 trillion in Treasury bonds starting later this year or early in 2011.
Some investors rushed to buy Treasuries on Tuesday, anticipating that the Fed would foster a continuing drop in interest rates. The 10-year Treasury note yield, a benchmark for mortgage rates and corporate bond rates, slid to a fresh 16-month low of 2.77% from 2.82% on Monday.
In its statement, the Fed’s assessment of the economy was largely unchanged from what the central bank described at its June 23 meeting, with one key difference: This time, policymakers said that “the pace of economic recovery is likely to be more modest in the near term than had been anticipated.”
The June 23 statement had said that the pace of the recovery was “likely to be moderate for a time.” But consumers’ spending has slowed this summer. An index of manufacturing activity has fallen for three straight months, though it’s still signaling expansion. On Friday, the government said the economy lost a net 131,000 jobs in July as temporary U.S. census workers were dismissed.
With the lack of job growth and other signs of weakness — and with a key inflation measure at a 44-year low — some Fed officials have signaled concern that the U.S. could fall into a deflationary cycle, marked by a sustained decline in prices for many goods, services and assets.
With the central bank’s benchmark short-term interest rate near zero since December 2008, the Fed has had to focus on other ways to try to support growth.
Many analysts had expected the Fed to resume acquiring bonds. Besides helping to restrain interest rates, the purchases put more money into the financial system as investors sell their securities to the Fed for cash. The theory is that more money in the system should help get the economy’s gears to turn faster.
But some economists have argued that another drop in long-term interest rates would benefit only those who can already easily get credit, such as Fortune 500 companies, without helping many smaller firms or individuals shut out of borrowing by banks that are reluctant to lend.
What’s more, despite mortgage rates at record lows, the housing market has struggled since the April 30 expiration of government tax credits for buyers. The average 30-year mortgage rate was 4.49% last week, down from 5% in early May.
Paul Kasriel, an economist at Northern Trust Co. in Chicago, said the Fed should be considering ambitious new loan-guarantee programs to funnel cash into the economy, particularly to smaller businesses.
Although analysts said it wasn’t clear how much the bond purchase program would help the economy, Kasriel said it was worth the effort because of the risk that the U.S. could tip back into recession. “It’s a more costly mistake to sit and do nothing,” he said.
But some Fed critics say the central bank has done enough for the economy and should avoid the risk of fueling longer-term inflation by pumping more money into the financial system at a time when government deficit spending is at all-time highs.
Thomas Hoenig, head of the Fed’s Kansas City bank, dissented Tuesday, saying he judged that “the economy is recovering modestly, as projected,” according to the Fed.
Hoenig also dissented at the Fed’s four previous meetings this year, objecting mainly to the Fed’s stated promise to keep short-term interest rates at “exceptionally low levels … for an extended period.”
Hoenig said he believed that promise was “no longer warranted,” the Fed said in its statement.
But with nine other policymakers again voting affirmative, the Fed maintained the “extended period” commitment in Tuesday’s statement.