Published: Wed, 18 Mar 2009 20:36:23 +0100

FOMC Decision to Buy Long Term Bonds Should Help Consumer Debt Markets

(CEP News) - The Federal Open Market Committee's decision to purchase up to $300 billion in long term government debt should have positive impacts on consumer and business lending rates, but economists warn that the world's largest economy still has a long way to go before recovering from the crisis.

"The Treasury market is smaller than the corporate and mortgage markets... so less money needs to be allocated to the market to achieve a similar sized decline in private sector borrowing rates," explained Eric Lascelles, chief economics and rates strategist at TD Securities.

Lascelles also pointed out that the decision has precedence with the Fed successfully targeting the yield on the 10-year note back in the 1940s.

Ian Shepherdson at HFE said the action was "inevitable", but admitted he didn't expect the Fed to move on this so soon.

Perhaps, "the immediate impact of the UK experience, which saw yields drop 60 basis points in two days after the BoE announced it would buy gilts, might have helped push [Fed Chairman Ben Bernanke] and his colleagues into action," Shepherdson said.

"We aren't sure $300B is enough, but this is a good start," he added.

The Federal Reserve's monetary policy committee also left the key interest rate unchanged, as expected, within a target range of zero to 0.25%, and committed to purchasing an additional $100 billion in agency debt and up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year.

However, not all are convinced the move will resolve all of the problems in the U.S. economy.

According to ING Economist James Knightley, Wednesday's decisions do "not necessarily guarantee an economic recovery and rising inflation as many in the markets seem to believe." He cited ongoing weakness in household and business confidence as crippling the lending markets.

Paul Dales at Capital Economics warned about the dangers of the Fed's rapid expansion of its balance sheet, which could have some important implications for inflation.

"The policies previously announced meant that the Fed's balance sheet was already going to double in size from around $1.5tn to $3trn. It is now likely to hit something like $4.5trn," he wrote.

Meanwhile, the FOMC seemed unconcerned about price growth for now, maintaining that it expects inflation to remain subdued in light of increasing economic slack in the U.S. and abroad.

"Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term," the statement said, matching January's statement.

The committee also said it will continue to "carefully monitor the size and composition of the Federal Reserve's balance sheet" in light of evolving financial and economic developments.

The market reaction was tumultuous, with yields on 10-year Treasuries seeing their largest declines in 47 years, shedding as much as 47 bps to below the 2.50% mark while two-year yields declined 16 bps to the 0.794% level.

On the currencies side, the U.S. dollar got slammed, losing as much as 4.5 cents to 1.346 euros, and 2.2 cents to 1.4257 against the pound sterling.

By Erik Kevin Franco, efranco@economicnews.ca; edited by Stephen Huebl, shuebl@economicnews.ca