Fed to move money to drive down long-term interest rates



WASHINGTON — The Federal Reserve will use more than $400 billion to try to drive down long-term interest rates, make home and business loans cheaper and invigorate the economy.

Analysts said the moves would provide only a slight economic benefit.

The action the Fed announced Wednesday is modest compared with previous steps it has taken. The Fed won’t expand its $2.9 trillion holdings; it’s just rebalancing them.

It will sell $400 billion of its shorter-term Treasurys to buy longer-term Treasurys by June 2012. And it will reinvest principal payments from its mortgage-backed securities, to help keep mortgage rates at super-low levels.

Fed policymakers announced the moves after a two-day meeting. Three members out of 10 dissented from the decision. The Fed acted despite criticism from Republicans who have warned that such steps could ignite inflation.

“The actions the Fed has taken are helpful,” said Josh Feinman, the global chief economist at DB Advisors. “They will help hold down long-term rates, but they’re no panacea.”

Stocks dropped immediately after the announcement about 2:20 p.m. and continued falling. The Dow Jones industrial average closed down about 283 points.

But the yield on the 10-year Treasury note tumbled to 1.86 – the lowest since the Federal Reserve Bank of St. Louis started keeping daily records in 1962. The 10-year yield is used to peg rates on a variety of loans, including long-term mortgages.

The plan the Fed unveiled Wednesday, dubbed “Operation Twist,” resembles a program the Fed used in the early 1960s to “twist” long-term rates lower relative to short-term rates.

In its statement, the Fed noted that the economy is growing slowly, unemployment is high and housing remains in a prolonged slump.

Under its plan, the Fed will extend the average maturity of its holdings from six years to eight years. The Fed has directed the New York Fed to buy Treasurys with remaining maturities of six to 30 years, and to sell an equal amount of securities with maturities of three years or less.

Analysts say the shift in the Fed’s portfolio could reduce borrowing costs and perhaps raise stock prices.

“This is a measured response to weak economic conditions,” said David Jones, the head of DMJ Advisors and the author of four books on the Fed.

The Fed completed a $600 bil­lion bond-buying program in June that many economists have credited with keeping rates low.

Jones said market anticipation of the Fed’s Operation Twist had sent long-term rates down by around 25 basis points for the 10-year bond.

He said that without the Fed’s move Wednesday, those rates would have risen. With the move, he predicted the 10-year bond would probably fall by another
5 basis points.

The Fed’s move Wednesday came despite a rift within the central bank. The three members who dissented also did so at the Fed’s August meeting – the most negative votes in nearly two decades.

The three dissenters – Richard Fisher, Narayana Kocherlakota and Charles Plosser, all regional Fed bank presidents –
have said the Fed’s policies might be raising the risk of high inflation. They favor giving the economy more time to heal without further Fed action.