How does this effect interest rates? Something to consider is that as bond prices rise,
interest rates fall. As bond prices fall, interest rates rise including large
movements in the Stock Market. This concept is simple if you think in
terms of where money comes from. Investors have basically 2 places to put
their money; in the stock market or the bond market. Since money is a
finite resource, if people are buying stocks, they typically have to pull that
money out of the bond market and vice versa, thus they typically move opposite
of each other. In October the fed will continue to buy mortgage
back securities but discontinue to buy treasury bonds. This might drive up
interest rates, however the fed has a very strong interest in keeping interest
rates low, as the housing and real estate sector are at the heart of our
crisis. Read on from articles from NPR and the New York Times-
NPR
By Laura Conaway
The Federal Reserve today announced that it will wind up its planned $300
billion program for buying government debt from financial institutions by the
end of October, since the economy is "leveling off." The Fed has bought
$253 billion worth of U.S.
Treasury bonds from banks in an effort to get more money moving through the
economy. If banks are holding cash instead of Treasurys, the thinking goes,
they'll be more likely to lend to people and businesses.
The Fed also announced it will not be raising its key interest rate, the
federal funds rate. This target rate is the amount the Federal Reserve hopes
banks will charge for overnight loans to other banks. The decisions come after
a two-day meeting by the Federal Open Market Committee, which sets monetary
policy and works to carry it out.
The Federal Reserve lowered the rate on Dec. 16, 2008, by a range -- of .75 to 1
percent -- to a record-low of zero to .25 percent.
Since then the economy has begun to show signs of turning around. Unemployment
dipped by .1 to 9.4 percent in July, exports are on the increase and gross
domestic product was shrinking more slowly last quarter than the quarter
before.
With such a low target rate, the Federal Reserve risks creating inflation when
the economy gets going again. The Fed began buying Treasurys from banks to
lower the interest rate and increase the supply of cash. The Fed has bought so
many government bonds that it has tripled its assets to $2 trillion in the last
year. Recently, the Federal Reserve Bank of New
York has reportedly been doubling its staff of
traders to help manage its ballooning portfolio.
If the economy does recover, demand will increase and producers may start
raising prices; a surplus of cash could fuel an uncomfortable level of
inflation. Some economists, including Allan Meltzer, have urged the Fed to
raise the rate soon.
So far, wages and most prices have stayed relatively flat. Last month, Fed
Chairman Ben Bernanke told Congress that he belives the rate will need to stay
low for "an extended period. Bernanke added, "[W]e also believe that
it is important to assure the public and the markets that the extraordinary
policy measures we have taken in response to the financial crisis and the
recession can be withdrawn in a smooth and timely manner as needed, thereby
avoiding the risk that policy stimulus could lead to a future rise in
inflation."
Today's statement, by Bernanke and the other Federal Open Market Committee
members, says the Fed "expects that inflation will remain subdued for some
time."
New York Times -
WASHINGTON — Almost exactly two years after it embarked on the biggest
financial rescue in American history, the Federal Reserve acknowledged on
Wednesday that the economy was pulling out of its downward spiral and announced
a step back toward normal policy.
Though the central bank stopped well short of declaring victory, policy makers
issued their most optimistic assessment in more than a year by noting signs of
stabilization in household spending, financial markets and inventory building
by corporations.
“Economic activity is leveling out,” the Fed board said Wednesday after a
two-day meeting.
In the statement, the Fed also said that “the committee expects that inflation
will remain subdued for some time.”
The central bank cautioned, however, that the recovery would slow and that
unemployment would probably remain high for the next year,and it reiterated
that it would keep its benchmark short-term interest rate at virtually zero for
an extended period.
But it also announced that it would wrap up its program to buy $300 billion
worth of Treasury bonds by the end of October. The program was one of several
tools invoked to drive down long-term interest rates and indirectly reduce the
cost of home mortgages and corporate borrowing.
The move signaled that policy makers were confident enough to remove one of
their emergency props for the financial markets. In its statement, the central
bank acknowledged that conditions in both the stock market and the credit
markets had improved in the last several months.
At the same time, Fed officials made it clear they were not about to throttle
back their biggest emergency credit programs. The central bank is barely
halfway through its plan to buy $1.25 trillion in mortgage-backed securities, a
program that directly affects home mortgage rates and has had a much more
noticeable effect than the Treasury bond program.
Analysts said the Federal Reserve had entered a wait-and-see period, continuing
to supply the economy with cheap money but not expanding or extending the
emergency programs beyond what policy makers had already been announced.
Despite growing confidence that the worst of the crisis is behind them, Fed
officials made it clear they were still more worried about rising unemployment
than a resurgence of inflation.
The government’s preliminary estimates show that the economy’s downturn slowed
sharply in recent months, contracting only 1 percent in the second quarter
compared with 6.4 percent in the first. The rate of job losses has slowed
sharply as well, though the nation still lost 247,000 jobs in July.
But the most recent forecasts by Fed policy makers anticipate that the economy
will begin an unusually slow recovery in the second half of this year and only
gradually pick up speed in 2010. Even if all goes according to plan, the Fed
forecast envisions that unemployment will climb from its already high level of
9.4 percent and average as much as 9.8 percent through the end of 2010.
“The balance of risks is still tilted toward weakness in growth and employment,
and not toward higher inflation,” said William C. Dudley, president of the
Federal Reserve Bank of New York
in a speech on July 29. Mr. Dudley said it was “premature to talk about ‘when’
we are going to exit from this period of unusual policy accommodation.”
Rising productivity rates in the United
States are giving the Fed more
maneuvering room. The productivity of workers, the amount produced per hour of
work, shot up at an annual rate of more than 6 percent in the second quarter
and has been climbing throughout the recession.
That is unusual for an economic downturn, but it means that wages have more
room to climb before employers start to raise prices for their goods and
services.
The Fed’s decision to end its program of buying Treasury bonds appears to
reflect both practical and philosophical concerns among some policy makers.
According to minutes of the Fed’s previous policy meeting in June, some policy
makers worried that the central bank’s heavy purchases of new Treasury debt
would be seen by investors as simply financing the federal government’s huge
deficits. That, they feared, would erode the Fed’s credibility and heighten
inflation expectations.
“Some of those who are less disposed to additional Treasury purchases worry
about the perception in the markets that they are motivated by a desire to help
the Treasury finance a mountain of debt,” Laurence H. Meyer, chief economist at
Macroeconomic Advisers, and a former Fed governor, wrote in a note to clients
last week.
By contrast, Mr. Meyer said, most policy makers seem to agree that the
mortgage-security program strikes at the heart of the economy’s biggest problem
— the housing market.
On a practical level, analysts said, the Treasury-buying program never packed
as much punch in the markets.
At $300 billion, the Treasury purchases are only one-quarter as big as the
mortgage program, and they have equaled only about one-third of the new
issuance of Treasury securities, according to Ira Jersey, an interest-rate
analyst at Royal Bank of Canada Capital Markets. By contrast, the Fed purchases
of government-guaranteed mortgage securities equaled more than 100 percent of
new issuance in that market.
Though mortgage rates have edged up in recent weeks, along with other long-term
interest rates, the spread between mortgage rates and risk-free Treasury rates
has narrowed by almost half since last November.
“The program to buy Treasuries wasn’t as effective as some of the other
programs, like the mortgage-security program, so ending it made sense,” Mr.
Jersey said.
