With growing outrage over AIG bonuses casting doubt on Congressional support for further government spending to stimulate the economy, and with no room left to lower short-term interest rates that are already at zero and the recent success of the Bank of England's long-term bond repurchase program, the Federal Reserve Bank launched a shock and awe attack on the recession today by announcing plans to buy up to $300 billion of long-term U.S. Treasury securities in the next few months and to increase the ceiling on purchases of mortgage-backed securities guaranteed by Fannie Mae and Freddie Mac from $500 billion to $1.25 trillion.
It’s the largest effort ever to use monetary policy to influence the world’s largest economy. Today’s Federal Open Market Committee’s press release had been expected to be a benign announcement about maintaining a zero Fed Funds rate. But instead the Fed dropped the monetary policy bombshell and caused a surge in prices for long-term bonds. The dramatic Fed announcement is a direct effort to drive down mortgage rates and reawaken the housing market, while also promoting lending to corporate borrowers and consumers. It precipitated the largest one-day drop in Treasury yields since the 1987 market crash, with the yield on 10-year Treasury notes plunging to 2.53% from above 3% just a day before. The rate on a 30-year fixed-rate mortgage for credit-worthy borrowers fell to about 4.75%. The risk of the Fed action is that it could weaken in the dollar at a time when America needs foreigners to invest in Government bonds to finance the stimulus packages. The dollar today declined by 3% against euro and gold surged 6.6%. The dynamics are explained in the video by FT columnist John Authers.