Fed is Back in Stimulus Game

Aug 10th, 2010 | By businessnews | Category: Business

August 10, 2010, 2:58 PM EDT

By Scott Lanman

(Updates with New York Fed statement in sixth paragraph.)

Aug. 10 (Bloomberg) — Federal Reserve officials will maintain their holdings of securities to prevent money from being drained out of the financial system in their first attempt to bolster the economy in more than a year.

The central bank said it will reinvest principal payments on its mortgage holdings into long-term Treasury securities. The Fed retained a commitment to keep its benchmark interest rate close to zero for an “extended period.”

“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said in a statement after meeting today in Washington. “To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level.”

Stocks pared losses, the dollar weakened and Treasuries rallied. With growth slowing in the second quarter and company job gains in July falling short of estimates, today’s step signals that risks of a downturn have increased enough for the Fed to delay its exit from unprecedented stimulus. Chairman Ben S. Bernanke told Congress last month that the Fed was “prepared to take further policy actions as needed.”

“With the economy slowing and inflation low, it is too early to pull in the horns,” said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “The last thing they want is a smaller balance sheet.”

Concentrating Purchases

The New York Fed, in a subsequent statement, said it aims to keep its holdings in the System Open Market Account at about $2.054 trillion, the amount it held on Aug. 4. The Fed plans to “concentrate its purchases” in two-year to 10-year Treasuries, the statement said.

The central bank will “continue to roll over” its holdings of Treasury securities as they mature, the FOMC said. The reinvestment policy applies to agency debt and agency mortgage-backed securities held by the central bank.

The central bank left the overnight interbank lending rate target unchanged in a range of zero to 0.25 percent, where it’s been since December 2008. High unemployment, low inflation and stable price expectations “are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” the Fed said, repeating language from every policy meeting since March 2009.

“The pace of recovery in output and employment has slowed in recent months,” the FOMC said. The Fed will “continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”

‘Subdued’ Inflation

U.S. central bankers repeated that inflation is “likely to be subdued for some time.” Prices in June rose 1.4 percent from a year earlier, the third straight month of slowing gains under the Fed’s preferred index, which excludes food and energy costs.

Kansas City Fed President Thomas Hoenig dissented from the decision for the fifth straight meeting.

Fed policy makers, at their last meeting in June, judged that the central bank “would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably,” according to minutes of the session. Records of today’s meeting will be released Aug. 31.

Bernanke said in an Aug. 2 speech that “we have a considerable way to go to achieve a full recovery in our economy.” Still, he avoided signaling that the central bank would reverse months of reductions in record stimulus and liquidity programs, including the end to $1.7 trillion in purchases of housing debt and Treasuries.

Bullard Comments

St. Louis Fed President James Bullard said July 29 that while he expects a continued recovery, policy makers should be ready to buy Treasuries if the economy slows further.

The Fed’s last move in favor of easier policy came in March 2009, when policy makers agreed to buy $300 billion of Treasuries and more than double planned mortgage-debt purchases to $1.45 trillion while starting a pledge to keep the benchmark rate close to zero for an “extended period.”

This year the central bank stopped buying assets, raised the rate on direct loans to banks and shut emergency-lending programs for corporations, bond dealers and money-market mutual funds. It’s also developed tools for raising rates with a near- record $2.3 trillion balance sheet.

Consumer Spending

The weak job market has inhibited growth in consumer spending, which accounts for about 70 percent of the economy. Such expenditures rose at a 1.6 percent pace last quarter, down from a 1.9 percent rate in the previous three months that was smaller than previously estimated.

Aeropostale Inc., a retailer to teenagers whose sales rose in July at one-seventh the pace analysts predicted, said changing consumer preferences and a “challenging” retail environment hampered spending. Sales at J.C. Penney Co., a department-store chain, fell 0.6 percent last month.

Still, Bernanke and other officials in recent weeks had maintained their outlook for a pickup in the economy over the next year. Corporate spending on equipment and software jumped at a 22 percent annual rate last quarter.

While weakness in housing and commercial real estate will restrain the recovery, and the job market’s “slow recovery” weighs on consumers, “rising demand from households and businesses should help sustain growth,” Bernanke said in a speech last week in Charleston, South Carolina.

Profit Outlook

United Parcel Service Inc., the world’s largest package- delivery company, raised its annual profit forecast last month and posted second-quarter earnings that climbed more than analysts estimated on increased demand overseas.

The S&P 500 Index has rebounded 12 percent as of yesterday from its low this year on July 1.

Investors don’t expect the Fed to raise the federal funds rate until late 2011, based on futures contracts on the Chicago Board of Trade.

The housing market has faltered since a federal tax incentive for first-time homebuyers expired in April. Sales of previously owned homes fell 5.1 percent in June from May, housing starts slid to the lowest level in eight months and the 330,000 annual pace of new-home sales was the second-lowest in data going back to 1963 after May’s 267,000 rate.

The National Bureau of Economic Research, an academic group with a committee that marks the start and end of recessions, has yet to announce a date for the end of the downturn that started in December 2007, even after four straight quarters of growth. Some panel members including Stanford University’s Robert Hall and Jeffrey Frankel of Harvard University have said it’s clear the contraction has probably ended.

–With assistance from Mark Crumpton, Caroline Salas and Allison Abell Schwartz in New York, Joshua Zumbrun in Washington and Mary Jane Credeur and Steve Matthews in Atlanta. Editors: James Tyson, Daniel Moss

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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