Fed, Citing Slowdown, to Buy U.S. Debt

Fed, Citing Slowdown, to Buy U.S. Debt
By SEWELL CHAN
Copyright by The New York Times
Published: August 10, 2010
http://www.nytimes.com/2010/08/11/business/economy/11fed.html?hp


WASHINGTON — The Federal Reserve acknowledged on Tuesday that its confidence in the economic recovery had dimmed, and announced that it would use the proceeds from its huge mortgage-bond portfolio to buy long-term Treasury securities.

Saying it would buy relatively modest amounts of government debt, analysts said the Fed signaled that it had no intention to back away from steps that it took, starting in 2007, to prop up the financial and housing markets. While the central bank held off on taking more aggressive steps, like a new, huge round of asset purchases, it left open the possibility that additional easing of monetary policy could take place in the fall if the recovery were to continue to weaken.

The Fed’s new stance marked the completion of a turnabout from a few months ago, when officials were discussing when and how to eventually raise interest rates and gradually shrink the $2.3 trillion balance sheet the Fed amassed through its response to the 2008 financial crisis.

In buying new Treasury securities to the tune of about $10 billion a month — a small fraction of the roughly $700 billion in Treasury debt sitting on the Fed’s balance sheet — the Fed will not let the balance sheet shrink for the time being.

More than anything, the announcement was a signal to the markets that the Fed was concerned about the pace of the recovery, and had shifted from its more optimistic assessment earlier this year, that economic growth was sufficiently strong to begin thinking about how to gradually return to normal monetary policy.

For now, the Fed is saying, normal is a ways off. “Information received since the Federal Open Market Committee met in June indicates that the pace of recovery in output and employment has slowed in recent months,” the Fed said in a statement.

The Fed bought $1.25 trillion in mortgage-backed securities, and another $200 billion in debts owed by government-sponsored enterprises, primarily Fannie Mae and Freddie Mac, and completed the purchases in March. The Fed had planned to allow the size of that portfolio to shrink gradually over time as the debts matured or were prepaid. Instead, the Fed will reinvest the principal payments in longer-term Treasury securities.

The central bank said it would continue to roll over its holdings of other Treasury securities as they mature.

In its announcement, the Fed also left unchanged its benchmark short-term interest rate — the federal funds rate, the rate at which banks borrow from each other overnight — at zero to 0.25 percent, the level it has been at since December 2008.

In a new qualification to its previous statements, the committee said it still expected a “gradual return” to normal economic conditions, “although the pace of economic recovery is likely to be more modest in the near term than had been anticipated.”

On Wall Street, shares regained some lost ground after the announcement.

Bruce McCain, the chief investment strategist at Key Private Bank, said the Fed “steered the middle ground” with the decision, while acknowledging the weakness that the market had been seeing in the economy.

“The fact that they committed to reinvesting was a little bit more than some had been looking for,” Mr. McCain said, “but at the same time it basically holds constant the size of their balance sheet.”

“Given the uncertainty, hopefully the middle ground calms nerves and keeps people confident enough to go ahead and spend the money that they have in productive ways,” he said, adding that the position suggested that the Fed did not expect an “enormous wave of economic weakness.”

Joshua Shapiro, the chief United States economist at MFR Inc., said the Fed’s announcement “appears to mainly be designed to provide itself with political cover against a backdrop of a gut-wrenching economic correction that shows no sign of ending anytime soon.”

He added: “Of course, if the economy deteriorates significantly further, today’s announcement could represent a down payment against more aggressive actions somewhere down the road.”

The Federal Reserve Bank of New York, which runs the trading desk through which the Fed conducts open market operations, released technical details on the transactions after the Fed meeting.

At its last meeting, in June, the committee downgraded its outlook and openly discussed the prospect of deflation — a declining spiral of demand, prices and wages — but cautioned that it was only likely to act if the situation took a serious turn for the worse.

Since that meeting, the Fed chairman, Ben S. Bernanke, and other Fed officials, had used cautious language in describing the state of the economy and the likelihood of new action by the central bank. In testimony before Congress last month, and at a speech in Charleston, S.C., last week, Mr. Bernanke said the economic recovery was continuing.

The Federal Open Market Committee’s vote on Tuesday was 9 to 1. The dissenter was Thomas M. Hoenig, president of the Federal Reserve Bank of Kansas City.

Mr. Hoenig has dissented repeatedly, asserting that the Fed’s stated policy of maintaining an “exceptionally low” level of the fed funds rate for an “extended period” was “no longer warranted.”

He dissented again, for the fifth time, on Tuesday, both on the extended-period language and on the decision to reinvest the mortgage-bond proceeds.

“Given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve’s holdings of longer-term securities at their current level was required to support a return to the committee’s policy objectives,” the Fed said in a statement.

Christine Hauser contributed reporting from New York.