Fed moves to juice US economy, but Wall Street wanted a jolt

The US central bank said Wednesday it will act to keep long-term borrowing costs low, to help stimulate the economy amid a weakening forecast. The Fed shaved 0.5 percent off its outlook for GDP growth this year.

Richard Drew/AP
Specialist Joseph Dreyer, right, watches the decision of the Federal Reserve as he works at his post on the floor of the New York Stock Exchange June 20. The Federal Reserve is extending a program designed to drive down long-term interest rates to spur borrowing and spending.
Brendan McDermid/Reuters
A trader works on the floor of the New York Stock Exchange as a news conference by US Federal Reserve Chairman Ben Bernanke is broadcast on a screen, on June 20.

In yet another effort to boost the US economy, the Federal Reserve Open Market Committee has decided to keep pushing down long-term interest rates, which could help people searching for a mortgage or corporations looking to do long-term financing.

However, the Fed's actions, termed Operation Twist because it involves the central bank selling short-term US treasuries and buying an equal amount of long-term bonds, disappointed those on Wall Street who had hoped to see more aggressive steps to stimulate the economy.

“I think there was a slight disappointment,” says Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Ore. “There was a little bit of anticipation [that] the Fed would hint at the timing of some kind of additional easing or economic stimulus.”

Wall Street was also somewhat disappointed, says Mr. Dickson, to hear the central bank's forecast for the economy: modest weakening and little pickup in hiring. And, in an indication that the Fed expects the economy to be in slow motion no matter who is elected president in November, the Fed says it will keep short-term interest rates low through the end of 2014.

In a press conference Wednesday, Federal Reserve Chairman Ben Bernanke called the central bank’s new steps “substantive,” and said the Fed is “prepared to do what is necessary to provide support for the economy.”

Mr. Bernanke indicated that the Fed could move interest rates still lower. Short-term interest rates are almost zero. The 10-year Treasury bill is about 1.46 percent, and the yield on the 30-year Treasury bond is about 2.72 percent. Reflecting these low interest rates, mortgage rates are at close to record lows – 3.63 percent for a 30-year fixed loan.

The Fed’s actions might do more than lower borrowing costs for people seeking mortgages or loans, Bernanke added. By buying securities from banks, the Fed might induce investors (such as banks) to buy corporate bonds, which would provide a better return, he said. Or, a bank may opt to make a loan instead of reinvesting the money in US Treasury securities.

Bernanke also indicated that some serious head winds are working against the nation’s central bank, such as the debt crisis in Europe, which has already driven some European nations into recession. This adversely affects US trade with Europe and has pushed down US stock prices.

In addition, the US housing recovery is not robust enough to help the general economy, Bernanke said. With home prices still falling in some places, spending is constrained because many Americans seeing their homes lose value feel poorer.

Finally, the Fed chairman noted that federal, state, and local governments continue to slow spending or reduce workforces.

 With all these headwinds, the Fed lowered its forecast for GDP growth by 0.5 percent for this year, 0.3 percent for 2013, and 0.1 percent for 2014. It also said it expected the unemployment rate would remain slightly higher than previously expected. “Our sense is that people are finding jobs but not at the rate we would like to see,” Bernanke said. 

Bernanke refused to step into the dispute in Congress over the budget and the extension of the Bush-era tax cuts. But he did observe that the dispute, if unresolved, could induce companies with government contracts to start laying off workers as the end of the year approaches.

“But it’s most important that Congress get the policy right,” he said. “Do no harm.” Any short-term fix, he said, might be a “negative.”

Independent Fed watchers say the Fed’s actions on Wednesday are meant to be more of a psychological boost than a practical one. “They have to show [that] the Fed still has ammunition,” says Sung Won Sohn, a professor of finance at California State University, Channel Islands. “They are pretty much the only game in town.”

Bernanke reinforced that view, saying the Fed does not accept suggestions that it has no more ammunition. “Our tools can still help us return to a more normal situation,” he said. “That being said, any other help to make the economy stronger is welcome,” he said, referring to fiscal policy.

However, Fed watcher and economist Bob Brusca, of Fact & Opinion Economics in New York, says the Fed’s actions are cautious. “It shows he doesn’t have any magic bullets, no new wisdom to impart,” says Mr. Brusca. “That is where we are.”

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