Federal Reserve buys up $2.5bn of bonds in 'not insignificant' move
Published 19/08/2010 | 05:00
THE US central bank has bought $2.5bn (€1.94bn) of US government bonds (treasuries) to prevent money being drained from the financial system.
It is the first outright purchase of US government debt by the Federal Reserve since October, but the newest member of the Fed's policy-setting Open Market Committee (FOMC) said interpretations of the Fed's actions have been too pessimistic.
The Fed statement last week announcing the bond purchases may have led investors to inaccurately believe the US economy is in worse shape than had been presumed, Narayana Kocherlakota said.
Mr Kocherlakota, who heads the Minneapolis Federal Reserve, said a "modest" recovery appeared to be under way.
The FOMC's move to reinvest repayments from mortgage-backed securities into treasuries "had a larger impact on financial markets than I would have anticipated", Mr Kocherlakota told business leaders yesterday at Northern Michigan University.
"The FOMC's decisions were largely predicated on publicly available data about real GDP, its various components, unemployment and inflation," he said.
"I would say that there is no new information about the current state of the economy to be learned from the FOMC's actions or its statement."
The problem for the Fed is that falling long-term interest rates over the past three months led more people to pre-pay and replace their mortgages, as they can easily do in the US.
Data yesterday showed re-financing applications jumped 17pc last week to reach the highest level since May 2009, while house purchases fell 3.4pc.
Where the Fed held the pre-paid mortgages, the shrinking of its holdings left a larger share of risk in the private sector. This could push up risk premiums on bonds and become a drag on the economy, Mr Kocherlakota said.
"The FOMC decided to arrest the decline," he said.
"On the face of it, this change seems minor, and almost operational in nature. However, it is not insignificant," JPMorgan Chase strategists Srini Ramaswamy and Kimberly Harano wrote in a report.
Analysts at the bank estimate the Fed will buy about $284bn in treasuries during the next year -- more than the combined purchases of Japan and China during the year ended May.
A survey by the Federal Reserve Bank of New York showed that US consumers reduced their debts by 1.5pc in the second quarter. At $11.7 trillion, it was 6.5pc less than its peak in the third quarter of 2008.
"Households in particular continue to be much more conservative than in the recent past," said Stephen Stanley, chief economist at Pierpont Securities in Stamford, Connecticut. (Bloomberg)