Fed Targets Long-Term Rates

Central bank plans to buy $400 billion long-term Treasuries, sell shorter maturities.

Federal Reserve policy makers will replace some bonds in their portfolio with longer-term Treasuries in an effort to further reduce borrowing costs and keep the economy from relapsing into a recession.

The central bank will buy $400 billion of bonds with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less, the Federal Open Market Committee said today in Washington after a two-day meeting.

The action is intended to “put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the FOMC said in a statement. The Fed will also reinvest maturing mortgage debt into mortgage-backed securities instead of Treasuries. Three officials dissented, the same as at the prior meeting in August.

Chairman Ben S. Bernanke expanded use of unconventional monetary tools for a second straight meeting after job gains stalled and the government lowered its estimate of second-quarter growth. Today’s action, dubbed “Operation Twist” by economists after a similar Fed action in 1961, may lower interest rates and avoids reprising the money creation that sparked Republican criticism last year.

“There are significant downside risks to the economic outlook, including strains in global financial markets,” the Fed statement said. Stocks and 10-year Treasury yields declined after the statement.

The Fed left unchanged its pledge to keep the benchmark interest rate near zero through at least mid-2013 as long as unemployment remains high and the inflation outlook stays “subdued.” The central bank has kept the target federal funds rate for overnight interbank loans in a range of zero to 0.25 percent since December 2008.

The Fed said it will release a schedule of purchases and sales of bonds for October on Sept. 30.


 
Rate Pledge
Policy makers amended the interest-rate pledge at their Aug. 9 meeting to substitute mid-2013 for the less-specific “extended period” that had been in FOMC statements since March 2009.

Inflation “appears to have moderated since earlier in the year,” the Fed said today. The Fed’s preferred price gauge, which excludes food and energy costs, rose 1.6 percent in July from a year earlier, accelerating from a 1 percent gain in March.

Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Charles Plosser of the Philadelphia Fed voted against the FOMC decision for a second consecutive meeting. They “did not support additional policy accommodation at this time,” the Fed statement said today.

The Fed’s System Open Market Account held $2.64 trillion in securities as of Sept. 14, which included $1.65 trillion in Treasury notes, bills and inflation-protected bonds and $995 billion of mortgage debt. The central bank purchased $2.3 trillion in debt from December 2008 through June in two rounds of so-called quantitative easing aimed at lowering borrowing costs for companies and consumers with the benchmark interest rate already at zero.


 
Maturities of Notes
Of the Fed’s $1.56 trillion in Treasury notes, 19 percent mature in less than two years; 35 percent have maturities of two to five years; 36 percent are due in five to 10 years; and 10 percent mature in 10 to 30 years, according to Bloomberg calculations based on New York Fed data. The average maturity was 6.1 years.

Economists surveyed by Bloomberg anticipated a Fed program today to extend the duration of its Treasuries. Of 42 surveyed analysts, 71 percent forecast such a move, even as 61 percent said it would probably fail to reduce unemployment.

The Operation Twist from 1961, conducted with the Treasury Department, got its name from Chubby Checker’s hit song, “The Twist,” according to a report published March 14 by Eric Swanson, an economist at the Federal Reserve Bank of San Francisco. That move lowered long-term Treasury yields by about 15 basis points, or 0.15 percentage point, according to Swanson.


 
Treasury Yields
Yields on 10-year Treasuries fell to a record low today on concerns global growth is flagging and Europe’s sovereign-debt crisis will intensify. The rate was 1.94 yesterday, compared with this year’s high of 3.74 percent in February.

The Standard & Poor’s 500 stock index has declined 12 percent through yesterday from its 2011 peak of 1,370.58 on May 2. The dollar has declined 2.5 percent this year against a basket of six currencies while rebounding 5.9 percent from a low on May 4.

Bernanke and his colleagues, who have a dual congressional mandate to achieve stable prices and maximum employment, are renewing their push to reduce 9.1 percent joblessness that’s crept up 0.3 point since March. It reached a 26-year high of 10.1 percent in October 2009.

“Importantly, nearly half of those currently unemployed have been out of work for more than six months, by far the highest ratio in the post-World War II period,” the 57-year-old former Princeton University economist said in July congressional testimony. By eroding skills, long-term unemployment “reduces the productive potential of our economy as a whole,” he said.

In the same remarks, Bernanke listed potential levers to ease policy including “more explicit guidance” for the low- rate pledge, which was used in August; buying more securities; lengthening the average maturity of holdings; and lowering the 0.25 percent interest rate paid on banks’ reserves.

He avoided further discussion of those options in two speeches over the past month, instead stressing that the Fed still has tools and announcing the expansion of this week’s meeting to two days from one to consider them. Many officials at the August meeting “saw increased downside risks to the outlook for economic growth,” minutes of the session said.

Excess bank reserves held on deposit by the Fed have increased to $1.57 trillion as of Sept. 7 from $969.4 billion in November, when the central bank began its $600 billion second round of asset purchases, also known as QE2.

That policy brought the Fed in for the strongest political criticism in three decades as Republicans, including Ohio Representative John Boehner, now the House speaker, said the central bank’s actions risked depreciating the dollar and causing too much inflation.

Republican lawmakers including Boehner and Senate Minority Leader Mitch McConnell urged Bernanke in a letter this week to refrain from additional monetary easing to avoid “further harm” to the economy.

The barbs have extended to the Republican campaign for the 2012 presidential nomination, with Texas Governor Rick Perry saying Aug. 15 that Bernanke would be treated “pretty ugly down in Texas” if he printed more money before the election.

“The Fed can replicate a lot of the effects of QE2 just by extending the maturity of its debt,” Dana Saporta, U.S. economist at Credit Suisse in New York, said before the decision.

While inflation has picked up this year, most FOMC members anticipated last month that it would “settle, over coming quarters, at levels at or below those consistent with the Committee’s mandate,” minutes of the August meeting said.

 

 

Bloomberg News

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