The Federal Reserve is to pump more than $1 trillion (£700bn) into the credit markets in a dramatic new move to push down interest rates. The US stock market soared on news of the additional help, which the Fed said was necessary to address the deteriorating economy. It is no longer explicitly predicting an end to the recession this year, and warned that slowdowns overseas were now compounding the problems for American businesses.
In a move that surprised investors, the Fed announced it would spend $300m buying US government debt over the next six months, a plan that is designed to drive down interest rates on the wide range of debt linked to Treasuries. It has long been mulling such a move but economists had expected it to keep its powder dry for the time being. The move to buy Treasuries mirrors the way in which the Bank of England has adopted quantitative easing policies in the UK.
In addition, the Fed is expanding its purchases of mortgage-backed securities by $750bn to $1.25trn, and doubling to $200bn the size of a programme to buy debt from the mortgage finance giants Fannie Mae and Freddie Mac. These programmes are designed to drive down mortgage rates.
The US central bank has been forced into printing money and making these kinds of interventions after reducing its official interest rate as low as it can go, to a range of 0 to 0.25 per cent in December. It reaffirmed that range yesterday after a meeting of the Federal Open Market Committee. The dislocations in the financial markets since the credit crisis began have meant the official rate – known as the Fed funds rate – has not been reflected across all types of debt, and consumers, mortgage borrowers in particular, are still paying higher rates and finding loans harder to come by than the Fed would like.
The economy had continued to contract since its last meeting in January, it said. "Job losses, declining equity and housing wealth, and tight credit conditions have weighed on consumer sentiment and spending.
"Weaker sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories and fixed investment. US exports have slumped as a number of major trading partners have also fallen into recession."
The closely examined statement also dropped the Fed's previous prediction that an economic recovery would begin later this year, replacing it with wording about "a gradual resumption" in economic growth but giving no set time-frame. That was perceived to be less optimistic than the views expressed by the Fed's chairman, Ben Bernanke, pictured below, in a weekend television interview.
An initial 2 per cent leap by the Dow Jones Industrial Average reflected surprise and excitement that the Fed would now be intervening in the Treasuries market, too, but equities were volatile as the afternoon's trading progressed. The Dow closed 90.9 points – 1.23 per cent – higher at 7,486.6.
US Treasuries soared and the yield on the benchmark 10-year bond declined 47 basis points to 2.54 per cent, the biggest drop since the stock market crashed in October 1987.
Rudy Narvas, senior analyst at 4Cast Ltd in New York, said: "It does reflect how dire they think the situation is. When you look at the statement, they talk about increasing economic slack and they weren't talking about increasing slack before."
The Fed's gloomy statement was jarring after two days of more positive economic data and a week-long stock market rally. Earlier yesterday morning, the latest US inflation figures, for February, had come in higher than forecast, easing concerns about deflation.Reuse content