Fed shifts its thinking and set to begin new pump-priming round
Published 11/08/2010 | 05:00
THE US Federal Reserve yesterday took a first step towards easing monetary policy, as it downgraded its view of the economic outlook amid rising fears that the US could face a "double-dip" recession.
At a meeting in Washington, Fed monetary policymakers agreed to begin reinvesting proceeds from expiring mortgage-backed securities in longer-term treasuries, thereby preventing a natural shrinking of the $2.3 trillion balance sheet the US central bank built up during the recession.
The move signals a significant shift in thinking at the Fed, which only a few months ago was tilting towards tightening monetary policy in order to fend off inflation as the economic recovery gathered strength.
But yesterday, Fed officials significantly downgraded their economic outlook, saying the "pace of recovery in output and employment has slowed in recent months". The pace of the recovery in the short term was likely to be "more modest" than anticipated.
The US Federal Reserve, in confirming a marked slowdown in the American economy, said it planned to buy long-dated US treasuries in an attempt to keep alive growth and maintain the vast amounts of money it pumped into the US economy during the financial crisis.
But rather than allocating new funds to the effort, the central bank said it would use the proceeds from its first $1.7tn quantitative easing (QE) cycle to buy the government bonds "in order to help support the economic recovery in a context of price stability".
The proceeds are estimated to be $200m to $300m over the next 12 months, allowing it to keep its balance sheet at close to its present $2.06tn.
The stock market had a cautious comeback after the news calmed investors' nerves. The Dow Jones industrial average, down about 100 points before the Fed announced its plans, recovered to a loss of 31. The other major market indexes also bounced back from their lows. But losing stocks were ahead of advancers on the New York Stock Exchange. And stocks considered safe bets, such as health care and consumer products companies, were among the gainers.
US bond prices also rallied. Prices pushed up across the board, but gains were the most pronounced in bonds maturing in the next five to seven years, after the Fed said it would reinvest the proceeds from expiring mortgage-backed securities into treasuries maturing in the next two to 10 years. Buying should help a weakening US economy by keeping mortgage rates low.
The Fed decision came as a surprise to some market participants. Some believed weaker data this spring and summer would push the Fed to give word it would continue to support the economy by buying more bonds, an effort originally launched during the credit crisis that was successful in keeping yields low.
The Fed bought roughly $1.7tn in mortgage and treasury debt in 2009 and early 2010. Others believed the Fed would wait, monitoring more economic data before making any revelations.
The Fed surprise came on the heels of more weak data yesterday. Non-farm business productivity unexpectedly fell and unit labour costs rose by less than expected. Wholesale inventories rose just 0.1pc, below the 0.6pc gain forecasters had expected. (Wire services)