Is The Fed's Buying-spree Ending?

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THE STASH AUGUST 5, 2009

Is The Fed's Buying-spree Ending?

That's what former Fed Governor Larry Meyer thinks. From Bloomberg:

The Federal Reserve is likely to let its plan to purchase up to $300 billion in U.S. Treasuries expire in mid-September as scheduled, and its decision may be announced next week, former Fed Governor Laurence Meyer said.

Plans to buy as much as $1.25 trillion of mortgage-backed securities and $200 billion of federal agency debt expire at the end of the year, so the decision on whether to extend them may be delayed, Meyer, vice chairman of St. Louis-based Macroeconomic Advisers LLC, wrote in a report released yesterday.

The Federal Open Market Committee “is unlikely to extend the life of these programs, unless, of course, either the economy or the financial markets take a significant turn for the worse,” Meyer said. “We therefore expect the FOMC to announce at its upcoming meeting that it will allow the Treasury purchase program to expire in mid-September.”...

“It is hard to justify becoming more aggressive with stimulus when the economy seems to be improving, many forecasters are revising forecasts upward and financial conditions have improved so sharply,” Meyer said in an interview.

What's a bit surprising here is that it was only a month or so ago that the Fed was being called upon to step up its asset purchases, including long-term Treasuries. And although signs of recovery are popping up everywhere, my sense is that there's still great uncertainty over the health of the financial sector, particularly if housing prices have yet to hit bottom.

It's unclear what effect, if any, the program has had on the 10-year: In the first few months after the program was announced, 10-year yields didn't play along and instead zoomed higher, topping out close to 4%. Since mid-June, yields have slipped and are floating around the 3.60-3.70% mark, but are still 1% higher than when the plan was announced. It's hard to say what the yields would have been absent the purchases, of course, but there's little affirmative evidence that the goal of the program -- "to reduce longer-term private sector interest rates" -- is being achieved. In any case, wouldn't it be better to target aid where it would be most effective? The Fed hasn't been shy about doing that with the help it's extended to a variety of money markets, for example. 

Still, there are a couple of things to like about the Treasury purchase program. First, when it comes time to reduce the size of the Fed's balance sheet (more than it has already this year), Treasuries will be easier to unload than some of the other securities it has taken on. And second--as a counterpoint to my gripe above--buying Treasuries does have a certain democratic appeal, since the Fed isn't picking winners: If there are any positive effects on the overall interest rate environment, anyone can enjoy the benefits.

That said, if the Fed does choose to end the Treasury purchases after one run, an improving economy may not be the only factor--the Fed could be signaling that the program wasn't all that useful. That's something the Fed has already done when it announced in June that it was closing up the never-tapped MMIFF facility (which was meant to increase confidence in the longer-than-overnight debt markets in the months after Lehman collapsed). We'll probably get a better sense for what the Fed really thinks of the Treasury purchases based on how long it lets other programs (like the TALF and CPFF) stay alive.

(Relatedly: The UK announced today it was ending extending a program of buying longer-term government debt. (The original link I put up was to a poll of primary dealers which had predicted the Bank of England would end purchases.)

--Zubin Jelveh

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