21 September 2011

Federal Reserve Board: Operation Twist, "Significant Downside Risk"' to the Economy

Nothing unexpected in today's Fed release. It was Operation Twist, with about $400 billion in Treasuries being rolled into the longer end of the curve from 6 to 30 years.

The Fed will be rolling over its Agency debt as it matured.

There was no decrease in the payment on Reserves as some had expected.

There is no additional expansion of the Balance Sheet which would be called QE3.

The only surprise was the statment of 'significant downside risk' to the economy which is a new emphasis. It is this statement which triggered a slight selloff in equities, but I would wonder how much of that is just a reallocation of capital into Treasuries which rallied sharply.

There were the same three dissenters: Fisher, Kocherlakota, and Plosser, who did not feel that economic conditions warrant additional accomodation at this time.

So in summary there is no outright expansion of the Balance Sheet, which is what people refer to when they say 'QE3.' The Fed is lengthening the maturity of its portfolio, which is rather large already, which will put downward pressure on the longer dates, most particularly the ten year note. And it will not be shifting its Agency debt to other investments or off balance sheet, but will reinvest them to target mortgage rates.

I might agree that the Fed's conventional policy action are reaching the limits of their effectiveness, and that additional legislative and fiscal policy actions are required. However, that does not mean that the economy would improve without them, or that they are no longer needed.

The next step will be for the Fed to consider less conventional, never before used policy actions, and perhaps a QE3. I doubt very much that they will do nothing as the economy continues towards a return to recession, or perhaps a deepening of the recession from which it never really recovered.

Personally I think the onus is on reform and fiscal policy, and as a regulator the Fed could do more in this area than it has otherwise done so far.

Federal Reserve Board

Release Date: September 21, 2011

For immediate release

Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased.

Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect some pickup in the pace of recovery over coming quarters but anticipates that the unemployment rate will decline only gradually toward levels that the Committee judges to be consistent with its dual mandate.

Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets. The Committee also anticipates that inflation will settle, over coming quarters, at levels at or below those consistent with the Committee's dual mandate as the effects of past energy and other commodity price increases dissipate further. However, the Committee will continue to pay close attention to the evolution of inflation and inflation expectations.

To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase, by the end of June 2012, $400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less.

This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.

To help support conditions in mortgage markets, the Committee will now reinvest principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. In addition, the Committee will maintain its existing policy of rolling over maturing Treasury securities at auction.

The Committee also decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.

The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen. Voting against the action were Richard W. Fisher, Narayana Kocherlakota, and Charles I. Plosser, who did not support additional policy accommodation at this time.