Federal Reserve & Interest Rates

The Federal Reserve announced on Wednesday that it would allocate an additional $1.05 trillion to purchase a combination of long term Treasuries and agency debt.  With interest rates pretty much at zero, much of the Fed’s focus has been on it’s balance sheet operations.

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.  The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. 

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.  Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.

For the short term,  mortgage rates are expected to hit their lowest levels since World War II.  While this should help spur the housing market, it will still be up to the banking system to meet the higher demand for credit this move will create.

There are also concerns in some circles about the long term inflationary impact because in essence the Fed is pretty much printing money to purchase these  securities.  After the Fed’s announcement, commodities had their biggest one day rally in months.

Much of the concerns is over how quick the Fed will be able to reduce it’s balance sheet once economic activity returns to normal.  It is also likely that the Fed’s balance sheet will continue to grow since it seems apparent that the administration will face increasing difficulties in seeking additional funds from Congress to deal with problems in the financial system due to the recent public outrage over executive compensation.

For the most part, little has been done up until now to deal with the problems in the housing market when compared to the attention being paid to the banking system.  The problems with both areas are related and it would be foolish to think you could fix one without dealing with the other.

Hopefully the fall in mortgage rates, combined with the Treasury’s plan to purchase toxic assets will be enough to finally turn around a housing market that has been in the dumps since 2007.