Fed extends Operation Twist to lower long-term rates

ByABC News
June 20, 2012, 3:43 PM

— -- The Federal Reserve, saying the economy has weakened recently, took a widely-expected step Wednesday to lower long-term interest rates for millions of consumers and businesses.

Stocks slumped after the announcement, but later turned mixed.

The Fed extended what is called Operation Twist, that is, shifting its Treasury portfolio from short-term to longer-term securities. The program was to end this month; the Fed said Wednesday that it will continue through the end of the year.

The Fed also decided to keep the federal funds rate, its key short-term interest rate paid by banks, near zero until at least late 2014.

In his press conference after the announcement, Fed Chairman Ben Bernanke said the Federal Reserve is open to buying more Treasury bonds to lower long-term interest rates and boost growth if the U.S. economy worsens.

"If we don't see further improvement in the labor market, we will be prepared to take additional steps if appropriate," Bernanke said.

The Fed said by year's end, it will have purchased about $267 billion in longer-term Treasury securities with maturities of 6 years to 30 years in Operation Twist and sold or redeemed an equal amount of securities with maturities of 3 years or less. It has already shifted about $400 billion since September, when Operation Twist began.

In continuing Operation Twist, the Fed seeks to "twist" long-term rates lower relative to short-term rates. Operation Twist has the advantage of potentially lowering long-term rates without expanding the Fed's record-high portfolio of securities. When the Fed adds to its portfolio of investments, that pumps cash into the economy and critics argue that it raises the risk of high inflation later.

The central bank chose not to take the more dramatic step of buying more Treasuries or mortgage-backed securities. That would have more sharply lowered long-term interest rates and boosted stocks but also raised concern about inflation.

Yet in a statement after its two-day meeting, policymakers said they're "prepared to take further action" to support the recovery if the economy worsens.

Economists were concerned the expiration of Operation Twist would push up borrowing costs just as job growth, factory output and retail sales have weakened due at least partly to the European financial crisis.

Analysts have said a decision to stand pat and let the program expire likely would have spooked investors and sharply driven down stocks.

In the statement after its meeting, policymakers noted Wednesday that the economy has weakened. "Growth in employment has slowed in recent months," the statement said. "Household spending appears to be rising at a somewhat slower pace than earlier in the year."

At the same time, the Fed said inflation has eased as oil and gasoline prices have fallen — a development Fed Chairman Ben Bernanke has suggested should help prop up consumer spending.

Despite this week's Greek election, leading to a coalition government that generally supports national budget cuts needed to ensure a critical bailout of the troubled country, Fed policymakers said, "strains in global financial markets continue to pose significant downside risks to the economic outlook."

Richmond Fed President Jeffrey Lacker was the lone dissenter among the Fed committee's 12 members, opposing the decision to extend Operation Twist.

The recovery has slowed this spring. U.S. employers added just 69,000 jobs in May. Since averaging a healthy 252,000 a month from December through February, job growth has slowed to a lackluster average of 96,000 over the past three months.