A Simple Twist of Rates
- The FOMC will launch a new “Operation Twist” in an attempt to lower long-term interest rates.
- The FOMC repeated its view that the Fed funds rate would remain near zero through mid-2013.
- According to the FOMC, economic growth remains slow and downside risks are significant.
- Inflation remains contained and no mention was made of changing an inflation target.
- Existing Homes Sales for August increased by 7.7 percent to a 5.03 million unit pace.
- The odds of a U.S. recession occurring before the end of 2012 are now up to 50 percent.
Today the FOMC voted to extend the average maturity of its balance sheet by purchasing $400 billion of Treasury bonds with remaining maturities of six to 30 years. This will be “sterilized” by the sale of an equal amount of Treasuries with remaining maturities of three years or less. More details of the “twist” are available from the Federal Reserve Bank of New York. The FOMC’s intent is to put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Fed will also now reinvest principal payments of agency debt and agency MBS into additional agency securities, thus directly working to lower mortgage rates. The Fed will maintain its current policy of rolling over maturing Treasuries. There is no change to Fed funds rate policy. The FOMC maintained their mid-2013 target for the near-zero Fed funds rate. The FOMC’s assessment of U.S. economic conditions was downbeat and downside risks were amplified to “significant”. Inflation is not viewed as a near-term constraint to monetary policy. The FOMC anticipates that inflation will settle in coming quarters to levels consistent with their dual mandate. Repeating the voting pattern of August 9, there were 3 dissents – Fisher, Kocherlakota and Plosser.
Existing home sales for August rebounded from a weak July, gaining 7.7 percent for the month to hit an annualized rate of 5.03 million units. This looks more like a correction from an undershoot in July than a sign that demand is picking up. Sales improved most in the West, up 21.9 percent. Soft mortgage apps so far in September suggest another flat month for home sales is in the works. In light of increased downside risks to growth, our subjective probability assessment of a recession before the end of 2012 is now 50 percent.
Market Reaction: Equity markets reacted negatively to the FOMC announcement. Treasury yields are up at the short end and down at the long end of the yield curve. Oil is down to $85.83/barrel. The dollar is gaining on the yen and the euro.