Fed takes bold, risky step to bolster economy

The Federal Reserve launched an unorthodox new policy on Wednesday, committing to buy $600 billion more in government bonds by the middle of next year in an attempt to breathe new life into a struggling U.S. economy.

The decision, which takes the Fed into largely uncharted waters, is aimed at further lowering borrowing costs for consumers and businesses still suffering in the aftermath of the worst recession since the Great Depression.

The U.S. central bank said it would buy about $75 billion in longer-term Treasury bonds per month as part of the new program. It said it would regularly review the pace and size of its purchases and adjust as needed depending on the path of the recovery.

Nearly 90 percent of its purchases would focus on Treasuries with maturities ranging from 2-1/2 to 10 years, the New York Federal Reserve Bank said in a statement.

"This provides the market with additional clarity," said Jeff Kleintop, chief market strategist at LPL Financial in Boston. "The question is whether this is enough."

Prices for 30-year bonds fell sharply after the Fed announced its decision, while major U.S. stock indexes hit sessions lows. The dollar fell against the euro.

The overall size of the program was slightly larger than the $500 billion that many analysts had looked for, however the pace of monthly buying fell short of expectations for something on the order of $100 billion.

"I am slightly underwhelmed," said Richard Franulovich, senior currency strategist at Westpac in New York.

Fed Says Disappointed on Economy's Progress

In its post-meeting statement, the Fed's policy-setting panel described the economy as "slow," and said employers remained reluctant to add to payrolls. It said measures of inflation were "somewhat low."

"Although the committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow," the Fed said.

The central bank repeated its vow to keep overnight rates ultra-low for an extended period. Some analysts had speculated the Fed might broaden this commitment.

Kansas City Fed President Thomas Hoenig continued his streak of dissents, saying the risk of additional securities purchases outweighed the benefits.

In its statement, the New York Fed said it would temporarily relax a rule limiting Fed ownership of any particular security to 35 percent. It said holdings would be allowed to rise above that threshold "only in modest increments."

Including the Fed's ongoing plan to reinvest maturing assets, the New York Fed expects to conduct $850 billion to $900 billion in Treasury purchases through the end of the second quarter of 2011.

With the U.S. economy expanding at only a 2 percent annual pace in the third quarter of this year and the jobless rate seemingly stuck around 9.6 percent, the Fed had come under pressure to do more to stimulate business activity.

The central bank had already cut overnight interest rates to near zero in December 2008 and bought about $1.7 trillion in U.S. government debt and mortgage-linked bonds.

Those purchases, however, occurred when financial markets were stricken by crisis, and economists and Fed officials alike are divided over how effective the new program will be.

Indeed, Hoenig and some other Fed officials worry further bond buying could do more harm than good by providing tinder for inflation that will ignite when the recovery finally gains traction.

Debating the Risks

With the prospect of a long period of ultra-low returns in the United States, investors have flocked to emerging markets, pushing those currencies higher. Emerging economies, worried about a loss of export competitiveness, have cried foul.

"We are all under attack by the relaxed monetary policy of the United States," Colombian Finance Minister Juan Carlos Echeverry told investors on Tuesday.

The Bank of Japan, which meets on Thursday and Friday, is also poised to launch a new round of bond buying.

The European Central Bank and Bank of England also meet

As things now stand, the U.S. economy is not growing quickly enough to put a dent in the unemployment rate, although a report on Wednesday suggested private sector hiring is slowly picking up.

With 14.8 million Americans unemployed, factories operating well short of capacity and inflation well below the 1.7 percent to 2.0 percent range the Fed shoots for, some officials at the central bank see the risk of a vicious deflationary cycle where consumers hold off on purchases, choking off economic growth.

The U.S. central bank already owns roughly 12.5 percent of all outstanding Treasury bonds and notes. If it were to buy $1 trillion more, as some economists expect it eventually will, the portion of its holdings compared with all outstanding Treasuries could jump to 27 percent.

A group of bond dealers that advises the U.S. Treasury expressed concerns about the possibility that a shortage of bonds could cause market disruptions, according to minutes from its November 2 meeting released on Wednesday.

[Source: By Pedro da Costa and Mark Felsenthal, Reuters, Washington, 03Nov10]

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