WASHINGTON, (Reuters) – The Federal Reserve yesterday took a small but significant step to counter a weakening U.S. economic recovery, saying it would use cash from maturing mortgage bonds it holds to buy more government debt.
The decision to reinvest proceeds from the nearly $1.3 trillion in mortgage-linked debt, acquired during the 2008 financial crisis in an effort to keep borrowing costs down, represents a policy shift for the central bank.
Until recently officials had been avidly debating an exit strategy from the extraordinary monetary stimulus delivered during the financial crisis, but recent signs of weakness forced the Fed to downgrade its economic assessment.
“The pace of recovery in output and employment has slowed in recent months,” the Fed said after a one-day policy meeting. In June, the Fed had described the recovery as “proceeding.”
The action took investors by surprise. Many had expected the Fed to keep policy unchanged for now, and those who did expect some reinvestment of housing-linked bonds believed the funds would be directed back into mortgage securities.
Analysts said the move could herald more aggressive monetary policy easing if more signs of a slowing economic recovery emerge.
“Should the outlook continue to worsen, the Fed will likely initiate a new round of asset purchases,” said Michael Gapen, economist at Barclays Capital.
Still, a Reuters poll of U.S. primary dealers — banks that deal directly with the Fed — showed only 5 of the 13 who offered their views on the issue believe the Fed will eventually resort to fresh buying of Treasury notes beyond the reinvestments announced on Tuesday.
U.S. stocks trimmed losses after the Fed’s decision, but still closed lower on the day. Treasury debt prices rose sharply, with the yield on benchmark 10-year notes slipping to 2.77 percent, near 15-month lows. The U.S. dollar fell against both the euro and the yen.
As expected, the Fed left benchmark overnight interest rates steady in a zero to 0.25 percent range and renewed its pledge to keep them low for an extended period.
Kansas City Federal Reserve Bank President Thomas Hoenig dissented for a fifth straight meeting over the Fed’s low-rate vow and said he believed the economy did not need further help.
Under the new regime, the Fed will keep its holdings of domestic securities steady at around $2.054 trillion, primarily by buying government securities ranging from two to ten years in maturity.
Investors were still trying determine just how much mortgage- and housing agency-backed debt held by the Fed would be maturing each year, with estimates hovering between $100 billion and $150 billion.
