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Fed to resume buying Treasury bonds

Posted by Greg Moser on August 11, 2010
| 5,503 Comments

Concerned about a slowing of the economic recovery, the Federal Reserve decided Tuesday to resume buying U.S. Treasury bonds in an effort to hold down longer-term interest rates.

The net effect will be to keep the Fed’s mammoth portfolio of about $2 trillion in U.S. Treasury bonds and mortgage-related securities constant, rather than allow the holdings to shrink as securities are paid off. The Fed bought the bulk of those bonds in 2009 via a program that has helped push mortgage rates to record lows.

Fed policymakers, holding their midsummer meeting, apparently rejected taking more dramatic steps to bolster the economy despite more evidence in recent weeks that growth was ebbing. But they signaled their unease, saying in their post-meeting statement that the recovery appeared more modest in the near term than had been anticipated. Their decision to buy more bonds had the desired effect in the market, pushing rates on Treasury securities to new lows for the year. The stock market, which was off sharply before the Fed’s statement, partly rebounded – suggesting that investors were at least relieved that the central bank acknowledged that the economy might need more help.

The Dow industrial average ended the day off 54.50 points, or 0.5%, at 10,644.25 after being down more than 145 points early on. With Congress increasingly balking at the idea of undertaking huge new stimulus spending programs, there has been more pressure on the Fed to do whatever it can to keep the economy from stalling out. Analysts called the Fed’s bond-buying commitment a modest move to underpin the economy. Rather than create new money from thin air to buy bonds, as it did in 2009, the Fed said it would use the proceeds from maturing mortgage bonds that it already owns to buy additional Treasury securities.

The Fed’s decision was a small and largely symbolic step … but it is support for the slowing economic recovery, nevertheless.

Analysts estimated that the Fed would have between $10 billion and $30 billion a month from mortgage-bond payoffs to use for Treasury purchases, the number could be about $25 billion a month, or $75 billion a quarter.

By comparison, the Treasury’s net borrowing to finance the federal deficit has been running at more than $340 billion a quarter. Some Fed watchers said the importance of the Fed’s move was that it cemented the view that Chairman Ben Bernanke would take whatever steps were necessary to keep the economy from falling back into recession. Economists at Goldman, Sachs & Co. predict that the Fed may be forced by a weakening economy to buy at least $1 trillion in Treasury bonds starting later this year or early in 2011. Some investors rushed to buy Treasuries on Tuesday, anticipating that the Fed would foster a continuing drop in interest rates. The 10-year Treasury note yield, a benchmark for mortgage rates and corporate bond rates, slid to a fresh 16-month low of 2.77% from 2.82% on Monday.

In its statement, the Fed’s assessment of the economy was largely unchanged from what the central bank described at its June 23 meeting, with one key difference: This time, policymakers said that “the pace of economic recovery is likely to be more modest in the near term than had been anticipated.”

The June 23 statement had said that the pace of the recovery was “likely to be moderate for a time.” But consumers’ spending has slowed this summer. An index of manufacturing activity has fallen for three straight months, though it’s still signaling expansion. On Friday, the government said the economy lost a net 131,000 jobs in July as temporary U.S. census workers were dismissed.

With the lack of job growth and other signs of weakness – and with a key inflation measure at a 44-year low – some Fed officials have signaled concern that the U.S. could fall into a deflationary cycle, marked by a sustained decline in prices for many goods, services and assets. With the central bank’s benchmark short-term interest rate near zero since December 2008, the Fed has had to focus on other ways to try to support growth.

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