Fed Will Try to Drive Interest Rates Even Lower

Sep 21, 2011 2:45pm

In an effort to drive long-term interest rates lower to boost the economy, the Federal Reserve said today it will do a debt swap, selling $400 billion of long-term securities for an equal amount of shorter-term instruments.

The Fed’s Open Markets Committee announced it intends to complete the purchase by the end of June 2012.   The new stimulus measure, dubbed Operation Twist, was received cooly on Wall Street, with the major stock indexes falling nearly 3 percent.

While the Fed’s move will bring down mortgage rates, which are already at historic lows, there’s worry that it will do little to create jobs and jumpstart the economy. Investors are concerned that the Fed has few tools left to stimulate business investment. The Fed said there’s “significant” downside risks to the economy, a word it hadn’t used at its last meeting.

“This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” according to a Federal Reserve statement.

The Federal Reserve repeated that economic conditions warrant “exceptionally low” interest rates through mid-2013, with inflation moderating slightly from earlier in the year.

The Fed also expects some pickup in growth in the coming quarters and that unemployment rate will decline only gradually.

The committee concluded a two-day meeting today in Washington D.C., one of eight scheduled meetings of the year.

In today’s announcement were the same three dissenting votes as in the last FOMC meeting: Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, presidents of the Federal Reserve banks in Dallas, Minneapolis and Philadelphia, respectively.

After the last meeting, the Federal Reserve released a statement Aug. 9 that it will keep the federal funds rate low, possibly at 0 to 1/4 percent, at least through mid-2013, which the committee reiterated today.

Through two years of quantitative easing, the Fed has already obtained about $1.7 trillion of federal bonds, or loans to the government. But Republican leaders in the House and Senate sent Federal Reserve Chairman Ben Bernanke a letter Monday, urging the Fed not to implement further stimulus. The protest is an unusual move as the Federal Reserve is an independent agency.

Senate Republican Leader Mitch McConnell of Kentucky, Senate Republican Whip Jon Kyl of Arizona, House Speaker John Boehner of Ohio and House Majority Leader Eric Cantor of Virginia said further action could increase the risk of additional inflation.

Guy LeBas, chief fixed income strategist with Janney Capital Markets, called the Fed’s assessment of economic conditions “pretty downbeat.” LeBas expected the Fed to purchase long-term treasuries without increasing the monetary supply.

“Fundamentally speaking, there’s very little the Fed can do to help the economy by lowering interest rates. Rates are so low already, [the Fed] is not going to encourage that much more borrowing,” he said.

The FOMC consists of twelve members: the 7 members of the Board of Governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York, and four of the remaining eleven Reserve Bank presidents, who serve one-year terms on a rotating basis.

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