September 21, 2010

With Nowhere to Go on Rates, Fed to Keep Buying Treasuries

FOMC action meets economists' expectations

The Federal Reserve's policy makers agreed Tuesday to keep interest rates at historic lows and to maintain its policy announced a month ago of reinvesting principal payments from mortgage bonds into Treasuries.

The Federal Open Market Committee (FOMC) voted to maintain the target range for the federal funds rate at zero to 0.25%, saying in a statement: "Household spending is increasing gradually, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit."

Economists had widely expected the Fed's policymakers to keep interest rates where they are. The FOMC, which holds eight regularly scheduled meetings during the year, has kept rates at historic lows near zero since December 2008.

"This is as expected. They didn't take any action, but they have clearly paved the way for giving the economy another booster shot of stimulus at their next meeting in November," said Jeff Kleintop, chief market strategist for independent broker-dealer LPL Financial in Boston.

Tim Courtney, CIO of Burns Advisory Group in Oklahoma City, who oversees about $425 million in assets at Burns and leads its investment committee's research team, said there was not a lot of difference between the FOMC's language on Tuesday and their official statement last month.

"I think they are caught in a position where there is not much more they can do right now," Courtney said. "Until they start to see better economic numbers they will probably keep rates as low as they can. As long as the M2 money supply does not get out of hand, they should just be able to stay where they are. The money supply is growing at around 3% annually, which is relatively low for a recovery."

Similar to the August 10 FOMC statement, the most striking part of Tuesday's statement was the Fed's announced plan to inject liquidity into the economy by using repayments on agency debts such as mortgage-backed securities to buy long-term Treasuries in the 5- to 20-year range.

Historically, the Fed has almost always provided one last shot of stimulus after a recession is over, Kleintop noted. On Monday, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER)--the nation's arbiter of when recessions begin and end--officially declared that the most recent recession ended in June 2009.

"With rates already at zero, the way the Fed will be providing the stimulus is through additional long-term large-scale asset purchases," Kleintop said.

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