Fed Doesn't Just Answer The Call To Action, It Answers It In A Big And Unprecedented Way

Friday, September 14, 2012 06:36
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Fed Doesn't Just Answer The Call To Action, It Answers It In A Big And Unprecedented Way

Tags: Federal Reserve | mortgage debt | Treasury bonds | U.S. economy

The markets got what they wanted and in historic fashion as the Federal Open Market Committee meeting concluded Thursday, September 13. Action was anticipated and action was delivered—in a big way.

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The Fed announced it would begin an open-ended program buying large quantities of mortgage bonds and would continue those purchases until the unemployment situation improves substantially. Other assets may also be included in the buying spree.
 
The announcement was significant and unconventional in multiple ways. Never before has the Fed announced action that would be tied to a specific economic goal. The focus of Fed action also shifted, no longer targeting inflation but illustrating a more determined effort to jumpstart the economy.
 
It was basically an admission that the cautious, incremental wait-and-see approach was not working. The Fed would now respond with deliberate, focused intention.
 
The announcement also indicated that the Fed would continue the purchases for a considerable time after the recovery becomes more solid. This means that higher inflation would be tolerated to the point of ensuring the economic recovery.
 
The Fed said it would add $23 billion worth of new bonds to its portfolio during the balance of September, indicating a $40 billion per month average in purchases. A new target will be announced at the end of each month until the economy improves enough to create sustainable job growth.
 
The target time horizon for keeping interest rates near zero was also extended, this time to mid-2015. Further, all but one committee member is targeting a shift at that point from keeping rates low to beginning to raise them.
 
That said, the committee was adamant that mid-2015 is not the time when it expects the recovery to begin. Instead, it’s an indication that the Fed intends to continue the shift from uncertainty to boldness at least until that time.
 
The Fed was almost completely unified in its statement on Thursday with only one committee member in dissent. The current Treasury purchases also will continue at least through the balance of 2012. Total Treasury purchase volume during that time is expected to be $85 billion per month.
 
Mortgage bonds were chosen because the housing market is already showing signs of strength and housing is one of the areas that can lead the economy to recovery while spurring job creation.
 
There is considerable doubt as to whether the Fed’s efforts will be effective. And they may not do much to directly impact economic growth. But the boldness of action is bound to improve sentiment, which could lead to a self-fulfilling and broader strengthening of the recovery.

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