Federal Reserve Announces Reinvestment Plans

The Federal Reserve has announced plans to reinvest principal payments on mortgage holdings into long-term Treasury securities. It will be the Fed’s first attempt to spur growth in the economy since last March to keep the sluggish US economy from falling back into recession. Fed officials also pledged a commitment to keep its benchmark interest rate near zero for an “extended period”.

With the economy’s growth slowing in the second quarter and job growth estimates for July unreached, the Fed’s move today indicates that the risk of a relapse into recession is significant. Fed Chairman Ben S. Bernanke had told Congress in July that the Fed was prepared to take further policy action as needed.

The Fed said they will roll over their holdings of Treasury securities as they mature, and that the policy will apply to agency debt and agency mortgage-backed securities held by the central bank. The central bank did not change the overnight interbank lending rate target, which has been in a range of 0 to 0.25 percent since December 2008. High unemployment and low inflation “are likely to warrant exceptionally low levels of the federal funds rate for an extended period,” a Fed statement said, in a repetition of language from every Fed policy meeting since last March. US central bankers concur with Fed statements, saying that inflation is likely to be sluggish for some time. Prices in June rose 1.4% from a year earlier, marking the third month in a row of slowing gains.

The last move made by the Fed in favor of easier policy came last March when they agreed to purchase $300 billion in Treasuries and more than doubled their planned mortgage-debt purchase to $1.45 trillion and also made a pledge to keep the benchmark rate close to zero “for an extended period”. Earlier this year the central bank stopped purchasing assets, raised the rate on direct loans to banks, and ended emergency lending programs for corporations, money-market mutual funds, and bond dealers. It has also created tools for raising rates with a near-record high $2.3 billion balance sheet.

Today’s decision did come as somewhat of a surprise after an August 6th report showed US private companies had added 71,000 jobs in July, below the estimate of 90,000 predicted by a Bloomberg survey. The unemployment rate remains unchanged, at 9.5 percent. Counting government employees, Americans lost 130,000 jobs in July, compared to the Bloomberg estimate of 65,000.

The continually struggling job market has hampered growth in consumer spending, which makes up about 70 percent of the US economy. Growth in consumer spending for the second quarter came in at 1.6 percent, following a 1.9 percent growth rate in the 1st quarter, both smaller than had been forecast. Bernanke and other Fed officials are maintaining a positive outlook for the economy over the next year.

Corporate spending on equipment and software rose last quarter at a 22 percent annual rate. United Parcel Service (UPS), the largest package delivery company, raised its expected annual profit forecast in July and posted second quarter earnings well above analysts’ estimates. The S&P 500 index has recovered 12 percent as of Monday from its low of the year set on July 1st.