The Federal Reserve on Thursday, in an effort to target
stubbornly high unemployment, offered an array of open-ended stimulus
programs designed to keep interest rates low until an economic recovery
gains significant traction.
In a strategy shift, the Fed’s latest round of quantitative easing,
commonly referred to as QE III, will target mortgage backed securities
rather than U.S. Treasuries. And, importantly, the Fed said it plans to
keep interest rates low even after a recovery gains momentum.
The Fed statement said it “expects that a highly accommodative stance
of monetary policy will remain appropriate for a considerable time
after the economic recovery strengthens.”
Federal Reserve Chairman Ben Bernanke hinted recently that Fed policy
could soon be tied directly to the U.S. labor markets. Without setting
specific targets, the Fed’s announcement did just that.
Stock markets soared on the announcement. The Dow Jones Industrial average was up more than 200 points at 3 p.m. EST.
In a statement, the Fed said, "If the outlook for the labor market
does not improve substantially, the committee will continue its purchase
of agency mortgage-backed securities, undertake additional asset
purchases, and employ its other policy tools as appropriate until such
improvement is achieved in a context of price stability.”
The disappointing August jobs report released on Friday, which
revealed that a meager 96,000 jobs were added last month, seemed to
confirm for many that the Fed would act in some significant way to
stimulate growth. While the unemployment rate fell last month to 8.1%
from 8.3% it was only because 368,000 people left the workforce
altogether, apparently having given up hope of finding a job.
“This is basically QE III, but it’s focused on the mortgage market
rather than the Treasury market,” said Gus Faucher, senior economist at
PNC Financial Services Group in Pittsburgh.
Fed: Housing Market Is Key Recovery
The new Fed policy suggests that a housing market recovery is key to
stimulating labor markets and eventually spurring a full-fledged
recovery, Faucher explained. By keeping mortgage rates low -- and
possibly pushing them even lower -- through Fed purchases it will
hopefully give the fledgling housing recovery some much-needed momentum,
he said.
In addition, Faucher said the Fed has made it clear it will act again if it feels the recovery fails to gain traction.
During a press conference Thursday afternoon, Bernanke said the new
open-ended policies are designed to “assure the public that the Fed will
remain accommodative long enough to ensure recovery.”
"We don't have a single number that captures that, but we anticipate
that we'll have to do more and we'll do enough to make sure the economy
gets on the right track," he added.
Bernanke, clearly aware of the political ramifications of Fed policy
with a presidential election looming, also took pains to explain that
asset purchases do not equate to government spending.
The Fed announced a program of mortgage backed securities purchases
valued at $40 billion each month. The Fed also said it would extend
Operation Twist, a program initiated a year ago designed to shift the
central bank’s portfolio toward long-term assets.
“These actions, which together will increase the Committee’s holdings
of longer-term securities by about $85 billion each month through the
end of the year, should put downward pressure on longer-term interest
rates, support mortgage markets, and help to make broader financial
conditions more accommodative,” the Fed statement said.
In addition, as had been widely predicted, the Fed said historically
low interest rates will remain in place through at least mid-2015.
Interest rates have been set at a range of 0%-0.25% since December of
2008, during the worst of the recent financial crisis.
“Information received since the Federal Open Market Committee met in
August suggests that economic activity has continued to expand at a
moderate pace in recent months. Growth in employment has been slow, and
the unemployment rate remains elevated. Household spending has continued
to advance, but growth in business fixed investment appears to have
slowed. The housing sector has shown some further signs of improvement,
albeit from a depressed level,” the Fed’s statement said.
The Fed was widely expected to address the stubbornly dormant U.S.
economy through some form of intervention intended to serve as a
stimulus. Opinions had varied widely over what form that intervention
was going to take and, more importantly perhaps, how effective it would
be.
How Effective Will the New Plan Be?
Now that the plan has been announced, those doubts have hardly been erased.
“We’re not sure what the economic effects of this program will be –
it should help growth and employment on the margin – but of all the
announcements the Fed could have made today, this is very nearly one of
the most accommodative that could have been reasonably expected,” said
Dan Greenhaus, chief global strategist at BTIG LLC.
Critics of the Fed’s long-term low interest rate policy note that the
strategy hurts anyone -- notably retirees -- who has invested in fixed
income securities such as bonds. Investment returns on bonds are derived
through the bond’s coupon which fluctuates with interest rates. Higher
interest rates mean higher coupons, which translate into better returns
for investors.
Savings accounts have also been all but useless as a means of
deriving income as interest rates have hovered near zero for almost four
years.
However, the Federal Reserve hopes that keeping pressure on short and
long-term rates will create a multiplier effect. Low rates could
encourage businesses to borrow and make investments across the economy.
Mortgage rates may also fall, helping to make home purchases more
attractive and adding to the burgeoning recovery in that sector.
“In determining the size, pace, and composition of its asset
purchases, the Committee will, as always, take appropriate account of
the likely efficacy and costs of such purchases,” the Federal Reserve
said, hinting at this cost-benefit analysis.
The Fed chief stressed repeatedly during his press conference that
central bank policy alone is not enough to cure high unemployment or
ward off a potential recession if the U.S. falls off the so-called
fiscal cliff early next year, when dramatic budget cuts and tax
increases will occur unless Congress reaches a compromise on government
spending and deficit reduction.
c Share Investor 2012