By Greg Robb | Market Watch | Sep. 13, 2012
WASHINGTON (MarketWatch) — The Federal Reserve, worried that improvement in the unemployment rate has stalled, announced a third round of bond purchases on Thursday in an effort to bring down long-term interest rates and spur economic growth.
The Fed said it would buy mortgage-backed securities at a pace of $40 billion per month.
The Federal Open Market Committee, which ended a two-day meeting on Thursday, said it was concerned that, without the action, “economic growth might not be strong enough to generate sustained improvement in labor-market conditions.” Read full text of statement.
“A weak job market should concern every American,” Fed Chairman Ben Bernanke said at his press conference.
In addition to bond purchases, the Fed said it intends to keep the benchmark short-term interest rate, known as the federal funds rate, at nearly zero until mid-2015. The prior guidance on the first rate increase had been late 2014. The guidance now extends well beyond end of Bernanke’s term in early 2014, although he could be appointed to another term by whoever is president. The central bank has kept the federal funds rate at nearly zero since December 2008.
The Fed said it would keep low rates in place for a “considerable time,” even after the economic recovery strengthens.
“Even after the economy starts to recover more quickly, even after the unemployment rate begins to move down more sizably, we are not going to rush to tighten policy. We are going to give it time to make sure the recovery is well established,” Bernanke commented.
“The Fed is being aggressive,” said Avery Shenfeld, chief economist for CIBC in Toronto. “They are taking action because every quarter that goes by, they haven’t gotten the growth that they forecast will one day come.”
U.S. stocks DJIA +0.32% spiked after the Fed statement was released. The U.S. dollar turned up and 10-year Treasury prices turned down. Read Market Snapshot.
The committee’s vote was 11 to 1. Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, dissented, as he has at every meeting this year. The Fed took the aggressive action out of a growing concern for the economic outlook, especially the anemic labor market.
A key element of the Fed’s statement was that the central bank will keep buying until more jobs are created, possibly at a faster rate.
“If the outlook for the labor market does not improve substantially, the committee will continue its purchases 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 FOMC said.
Bernanke added that the Fed’s asset purchases would not last until the labor market was back to full employment: “We’re just trying to get the economy to move in the right direction, make sure that we don’t stagnate at high levels of unemployment.”
“They are saying that they will not pause until their work is done,” CIBC’s Shenfeld said.
Despite holding interest rates at zero for more than three and a half years, and the central bank buying $2.3 trillion in assets, the unemployment rate has been stuck above 8% since early 2009. There are 12.5 million unemployed workers.
Economists and even Fed officials disagree on whether further asset purchases will have any lasting effect on the economy.
Shenfeld of CIBC compared the Fed move to a placebo. “They are saying, ‘Take these two bond-buying programs and you will feel better in the morning,’ ” he said. “The reality is that the weapons they have are not particularly powerful, but they might as well be used.”
Fed hawks are worried that core consumer-price inflation is running at a 2.1% rate over the past 12 months despite the weak economy. In response, Bernanke said the Fed was ready to combat any inflation outbreak. “The Fed has both the tools and the will to act at the appropriate time to avoid any emerging threat to price stability,” he remarked.
He addressed the continued concern that savers are being hurt by the Fed’s drive to push down rates. Bernanke noted the Fed was aware that savers were hurt by the low rates, but said everyone would ultimately benefit if the economy picked up steam as a result of the purchases.
The Fed chairman also said the “broad center” of the Fed supported the move to QE3, and that he was not concerned with opposition to the program from inside or outside the Fed.
“Some people think it is more effective than others. There is going to be disagreement. I do think it has enough force to help nudge the economy in the right direction,” he added.
Economists expect sluggish growth for the last six months of the year. The European sovereign-debt and banking crises are holding the economy back.
There is also mounting concern over a stalemate over U.S. fiscal policy. Deep spending cuts and higher taxes will take effect Jan. 1 unless the Republican and Democrats in Congress agree to change current law.
St. Louis Fed President James Bullard said in an interview with MarketWatch late last month that the end dates of the first two rounds of asset purchases damaged their effectiveness. Read interview.
Republicans have been opposed to the Fed’s asset purchases as government intervention in the economy. On Wednesday, vice presidential candidate Paul Ryan said he thought they would do “more harm than good.”
President Barack Obama generally has not commented on Fed policy.
Bernanke said that prior rounds of quantitative easing had worked and could continue to be effective. “Overall … a balanced reading of the evidence supports the conclusion that central-bank securities purchases have provided meaningful support to the economic recovery while mitigating deflationary risks.” The costs of the program also “appeared manageable.”
The first two rounds of asset purchases may have increased private payroll employment by more than 2 million jobs, according to the Fed chief.
Since the recession ended in June 2010, the economy has added a total of 2.8 million private sector and government jobs.
In its statement, the FOMC said that the economy is growing at a moderate pace. Business spending appeared to have slowed. Housing was showing further signs of improvement but from a depressed level.
The FOMC said that inflation “has been subdued,” even though some key commodities have increased recently.
The Fed said that strains in global financial markets continue to pose significant downside risks to the outlook.
The central bank will continue its Operation Twist plan to replace short-term securities on its balance sheet with long-term bonds. It will also maintain its existing policy of reinvesting principal payments in MBS.
The actions will together increase the Fed’s holding of longer-term securities by about $85 billion each month through the end of the year, the Fed added.
The purchases “should put downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative,” the Fed said.
The next decision will come in December when it must decide whether to continue the purchases at the $40 billion per-month pace or ramp them up as the Twist program ends.
Asked to define what the specific conditions would be that would cause the Fed to stop, Bernanke replied: “Ongoing, sustained improvement in the labor market.”
“It is not a specific number we have in mind. But, you see the last six months? That isn’t it,” he said.