Federal Reserve policy makers will replace some bonds in theirportfolio with longer-term Treasuries in an effort to furtherreduce borrowing costs and keep the economy from relapsing into arecession.

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

The action is intended to “put downward pressure on longer-terminterest rates and help make broader financial conditions moreaccommodative,” the FOMC said in a statement. The Fed will alsoreinvest maturing mortgage debt into mortgage-backed securitiesinstead of Treasuries. Three officials dissented, the same as atthe prior meeting in August.

Chairman Ben S. Bernanke expanded use of unconventional monetarytools for a second straight meeting after job gains stalled and thegovernment lowered its estimate of second-quarter growth. Today'saction, dubbed “Operation Twist” by economists after a similar Fedaction in 1961, may lower interest rates and avoids reprising themoney creation that sparked Republican criticism last year.

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

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

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

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

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

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

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

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

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

The Operation Twist from 1961, conducted with the TreasuryDepartment, got its name from Chubby Checker's hit song, “TheTwist,” according to a report published March 14 by Eric Swanson,an economist at the Federal Reserve Bank of San Francisco. Thatmove lowered long-term Treasury yields by about 15 basis points, or0.15 percentage point, according to Swanson.

Treasury Yields
Yields on 10-year Treasuriesfell to a record low today on concerns global growth is flaggingand Europe's sovereign-debt crisis will intensify. The rate was1.94 yesterday, compared with this year's high of 3.74 percent inFebruary.

The Standard & Poor's 500 stock index has declined 12percent 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 ofsix currencies while rebounding 5.9 percent from a low on May4.

Bernanke and his colleagues, who have a dual congressionalmandate to achieve stable prices and maximum employment, arerenewing their push to reduce 9.1 percent joblessness that's creptup 0.3 point since March. It reached a 26-year high of 10.1 percentin October 2009.

“Importantly, nearly half of those currently unemployed havebeen out of work for more than six months, by far the highest ratioin the post-World War II period,” the 57-year-old former PrincetonUniversity economist said in July congressional testimony. Byeroding skills, long-term unemployment “reduces the productivepotential of our economy as a whole,” he said.

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

He avoided further discussion of those options in two speechesover the past month, instead stressing that the Fed still has toolsand announcing the expansion of this week's meeting to two daysfrom 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 increasedto $1.57 trillion as of Sept. 7 from $969.4 billion in November,when the central bank began its $600 billion second round of assetpurchases, also known as QE2.

That policy brought the Fed in for the strongest politicalcriticism in three decades as Republicans, including OhioRepresentative John Boehner, now the House speaker, said thecentral bank's actions risked depreciating the dollar and causingtoo much inflation.

Republican lawmakers including Boehner and Senate MinorityLeader Mitch McConnell urged Bernanke in a letter this week torefrain from additional monetary easing to avoid “further harm” tothe economy.

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

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

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

Bloomberg News

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