Fed Sees ‘Significant’ Risks to U.S. Economy

By Joshua Zumbrun and Scott Lanman - Sep 22, 2011 4:08 PM GMT+0700

Federal Reserve policy makers indicated they are willing to do more to keep the economy from sliding into another recession as they made their second move in as many months to reduce borrowing costs.

The central bank will extend the average maturities of the Treasuries in its portfolio by purchasing $400 billion of long- term debt while selling an equal amount of shorter-term securities, the Federal Open Market Committee said in Washington after ending a two-day meeting yesterday.

“It’s a modest step,” said Dean Maki, chief U.S. economist at Barclays Capital and a former Fed economist. “This is a way to start down the path of further easing, but they would become more aggressive if they were convinced growth was not going to improve.”

Treasury 30-year bonds surged in anticipation of central bank purchases of longer-term debt. Stocks fell, pushing the Standard & Poor’s 500 Index down the most in a month, on the Fed’s assessment that market turmoil caused by Europe’s sovereign-debt crisis is taking a toll on the U.S. economy.

“There are significant downside risks to the economic outlook, including strains in global financial markets,” the FOMC said. “The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability.”

Global Stocks Tumble

Stocks and commodities fell, Treasury 10-year yields dropped to a record and the Dollar Index climbed to a seven- month high.

The MSCI Asia Pacific Index plunged as much as 3.8 percent in Tokyo and Europe’s benchmark Stoxx 600 Index slumped 3.4 percent at 10:03 a.m. in London. U.S. stock futures dropped, signaling the world’s largest equity market may slide for a fourth straight day. The S&P 500 Index (SPX) tumbled 2.9 percent yesterday.

The Fed’s move, known as “Operation Twist” after a similar action in 1961, drew three dissents for the second meeting in a row, as Chairman Ben S. Bernanke struggled to find consensus to help an economy beset by 9.1 percent unemployment and prices that are 3.8 percent higher than a year ago, as measured by the Consumer Price Index.

The Fed will probably increase the bond-buying program announced yesterday in coming months, said companies including ING Groep NV, Mitsubishi UFJ Asset Management Co. and Wells Fargo LLC.

Rate Pledge

The Fed maintained its pledge made in August to hold its benchmark interest rate near zero through the middle of 2013 so long as unemployment stays high and the inflation outlook is “subdued.” The target rate has been in a range of zero to 0.25 percent since December 2008.

The central bank also announced a measure “to help support conditions in the mortgage market” by reinvesting maturing housing debt into mortgage-backed securities instead of Treasuries.

Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates tumbled the most in more than two years relative to Treasuries after the announcement.

“The Fed is trying to drive down mortgage rates to the lowest possible level, to get people to refinance, get more disposable income in people’s pockets,” said Michael Dueker, chief economist for Russell Investments North America in Seattle, with $161 billion in assets under management.

Inflation Outlook

The amount of Treasury debt to be sold represents about three-fourths of Fed holdings of between three months and three years. The program will extend the average maturity of the Fed’s Treasury holdings to 100 months, or 8 1/3 years, by the end of 2012, from 75 months.

Inflation “appears to have moderated since earlier in the year,” the Fed said, without citing a specific measure. 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. At the same time, retail gasoline prices have declined to an average of $3.57 a gallon from $3.99 in May.

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.

Republican Backlash

The Fed’s efforts to spur growth, including purchases of $2.3 trillion in securities from December 2008 through June in two rounds of so-called quantitative easing, have sparked a backlash from Republican lawmakers.

House Speaker John Boehner of Ohio and Senate Minority Leader Mitch McConnell of Kentucky urged Bernanke in a letter this week to refrain from additional monetary easing to avoid “further harm” to the economy.

The criticism has 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’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.

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

‘Noticeable Impact’

“We saw a noticeable impact on longer-term securities,” said Ryan Sweet, senior economist at Moody’s Analytics in West Chester, Pennsylvania, who estimates the lower borrowing costs may add 0.1 percentage point to gross domestic product in the fourth quarter. “The Fed has to take strides to restore confidence. The economy is really being held back by a crisis of confidence.”

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.

Some borrowing costs were already nearing record lows before yesterday’s action.

Yields on 10-year Treasuries have been falling on concerns global growth is flagging and Europe’s sovereign-debt crisis will intensify. The rate fell to 1.86 percent yesterday from this year’s high of 3.74 percent in February. The average rate for a 30-year fixed mortgage fell to 4.09 percent last week, its lowest level on record in a Freddie Mac index dating to 1972.

Joe Carson, director of global economic research at AllianceBernstein LP in New York, said consumers are likely to see little relief in the form of lower costs to pay interest on their debts, which are already at a 15-year low after falling by $250 billion since the middle of 2007.

“It will have a very minor impact on activity because our economy is not being hurt by high interest rates,” Carson said.

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net