Markets & Finance

Economists Weigh In on the Fed's Shocker


The markets were jolted by the central bank's bold plan to buy up to $300 billion of longer-term Treasury securities to help thaw private credit markets. Here's what economists had to say

By BW staff

Who said the Federal Reserve could no longer make a splash in the markets after policymakers lowered the benchmark U.S. interest rate to near zero? Treasuries and stocks soared on Mar. 18 after the Fed, at the conclusion of its two-day policy meeting, said it would boost its already enormous balance sheet by purchasing up to an additional $750 billion of agency mortgage-backed securities (MBS) and by hiking its purchases of agency debt this year by up to $100 billion, to a total of up to $200 billion.

The thing that really goosed the markets, though, was this statement in the Fed's post-meeting communique: "Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months."

What did Wall Street economists have to say about the Fed's move? Here is a sampling, as compiled by BusinessWeek staff:

John Ryding and Conrad DeQuadros, RDQ Economics

The Fed has decided to be the central bank that swallowed the Bank of England's canary. It has eased rates to zero and intends to keep them there for some time. It has massively upsized its balance sheet support for the agency MBS market. It is likely to expand the TALF (Term Asset-Backed Securities Loan Facility) program to include non-agency MBS. It is now going to engage in traditional quantitative easing in the form of monetizing some of the rapidly exploding government debt. Adding up these programs puts the Fed's balance sheet somewhere around $4.5 trillion before the end of this year. From a credit market perspective (and quite possibly an equity market perspective), this is all good news. We are not, however, convinced of the sustainability of the Treasury rally (10-year yields fell about 50 basis points in response to the news—very similar to the move in the gilt market). However, the scale of the Fed's proposed purchases of Treasuries (relative to the size of the debt and the deficit) is much smaller than the Bank of England's purchase (it would have had to be well above $1 trillion to be comparable).

In addition, we are not convinced that we are headed for deflation (and derive support for that view from the recent producer price index and consumer price index data), and we worry about the longer-term inflation implications of these purchases. We think the Treasury rally will be short-lived, and see these purchases as negative for the dollar against foreign currencies and gold.

Ken Kim, Stone & McCarthy Research Associates

As we suspected, the [Fed's] Federal Open Market Committee announced that it would maintain the target range for the federal funds rate at 0% to 0.25%. However, the FOMC lengthened the time frame in which the fed funds rate would remain at such exceptionally low levels. Today, the FOMC stated that the fed funds rate would remain there "for an extended period." In the last meeting held at the end of January, the FOMC had stated that it would remain there for "some time." We interpret the switch in words as signaling a longer time commitment by the Fed.

The FOMC also announced today that it is increasing the size of its balance sheet. What was notable about this part of the announcement was that the Fed will be purchasing up to $300 billion of longer-term Treasury securities over the next six months.

Most commentators, including ourselves, believed Fed purchases of longer-term Treasury securities was placed on the back burner for now, given the lack of indirect or direct confirmation of such a possibility in recent Fed appearances, including [those by] Bernanke himself.

On the economy and inflation, the FOMC said the near-term economic outlook is weak and there is some risk of deflation, which is not a surprise to us.

Ryan Sweet, Moody's (MCO) Economy.com

Catching markets off guard, the Federal Reserve announced a pure quantitative easing regime on Wednesday. The Fed will begin purchasing $300 billion in longer-term Treasury securities to influence interest rates. Also, it will expand the TALF and purchase an additional $750 billion in agency mortgage-backed securities, bringing its total purchases of these securities to $1.25 trillion. The Fed is pulling out all the stops to restore confidence, stabilize financial markets, and stimulate the economy. The FOMC left the target range for its fed funds rate unchanged at 0% to 0.25%.

The decision was unanimous, which is important, as the central bank must appear unified as it navigates in uncharted waters.

Action Economics

Yields plunged sharply after the Fed moved to radically expand its balance sheet via purchases of $300 billion in Treasuries over the next six months, in addition to boosting agency purchases by $100 billion and MBS purchases by $750 billion as well. The benchmark 10-year yield had been trading in the 2.95% area before collapsing to 2.65%, while the 30-year yield slumped from the 3.75% area to 3.53%.

With the Fed's hands tied near zero percent on the Fed funds target, this has effectively delivered a half-point cut to the markets, so long as long-term market interest rates remain lower and are not undermined by the dollar's slump.


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