Fed's Effort to Bolster U.S. Recovery Fails to Calm Investors

The Federal Reserve’s first attempt to bolster the flagging U.S. recovery shows no sign of dispelling investor concerns the world’s largest economy may slide back into a recession.

The Standard & Poor’s 500 Index fell for a third straight day yesterday after paring losses in the hours after the central bank’s Aug. 10 announcement it would sustain its assets at the current level. A subsequent decline in 10-year Treasury yields hasn’t yet filtered through to corporations now paying higher premiums.

The central bank said it will buy Treasuries with proceeds from mortgage holdings and set a $2.05 trillion floor on its holdings of government bonds and housing debt to buoy an economic recovery it said is slower than forecast. The Fed’s failure to spell out its objectives may have fanned investor anxiety the expansion wouldn’t last, said Charles Lieberman, a former New York Fed official.

“The Fed is effectively saying that they need to find ways to resuscitate the economy, and the mere fact that they’re acknowledging that reinforces the fear that’s out there,” said Matthew Kaufler, a money manager at Federated Clover Investment Advisors in Rochester, New York, which manages $3 billion.

The central bank’s statement followed a government report last month showing the recession that started in December 2007, already deemed the deepest since the 1930s, was worse than estimated.

Photographer: Roger L. Wollenberg/Pool via Bloomberg

The central bank said it will buy Treasuries with proceeds from mortgage holdings and set a $2.05 trillion floor on its holdings of government bonds and housing debt to buoy an economic recovery it said is slower than forecast. Close

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Photographer: Roger L. Wollenberg/Pool via Bloomberg

The central bank said it will buy Treasuries with proceeds from mortgage holdings and set a $2.05 trillion floor on its holdings of government bonds and housing debt to buoy an economic recovery it said is slower than forecast.

A July 30 revision by the Commerce Department showed household spending fell 1.2 percent in 2009, twice as much as previously projected and the biggest decline since 1942. Also, companies reported hiring a less-than-forecast 71,000 employees last month.

‘Created Worries’

“They’ve actually created worries in the market that things are going to be worse than people previously thought,” Frederic Mishkin, a Columbia University economist and former Fed governor, said yesterday in an interview on Bloomberg Television’s “InBusiness with Margaret Brennan.”

The Fed said this week that “the pace of economic recovery is likely to be more modest in the near term than had been anticipated.” Policy makers repeated their pledge to keep interest rates “exceptionally low” for an “extended period.” The Fed’s benchmark rate has been at a range of zero to 0.25 percent since December 2008.

Equity Markets

“Investors’ interpretation is, ‘What does the Fed know that we don’t?’” about concerns such as foreclosures and financial regulation, said John Lynch, chief equity strategist at the Wells Fargo Funds Management division of San Francisco- based Wells Fargo & Co. that oversees $465 billion. The decline in equity markets reflects “investors extrapolating from the statement.”

Stock markets around the world fell this week. The MSCI World Index of stocks in 24 developed nations dropped 2.84 percent on Aug. 11 and 0.61 percent yesterday as of 4:30 p.m. in New York.

The Nikkei 225 Stock Average fell 0.86 percent yesterday and 2.7 percent on Aug. 11. The Standard & Poor’s 500 fell 0.5 percent to 1,083.61 yesterday. The index, while down 2.8 percent for 2010, is up 7.2 percent from its low for the year on July 1.

“The market didn’t see the Fed’s statement as providing significant support for the economy,” said Lieberman, chief investment officer at Advisors Capital Management LLC in Hasbrouck Heights, New Jersey. “It saw what the Fed was doing as relatively minor in size and importance.”

Yields on 10-year Treasury securities rose yesterday to 2.75 percent from 2.68 percent after starting the week at 2.82 percent and the year at 3.84 percent.

Bond Price

The average investment-grade bond price has jumped about 5.5 cents to 110.65 cents on the dollar this year, while the average high-yield price has gained more than 3 cents to 98.76 cents on the dollar, according to Bank of America Merrill Lynch index data.

The Fed could have been clearer in the statement about how its action would help the economy and sent a stronger signal that it was prepared to take further steps should the economy weaken, Lieberman said, adding investors are probably being too pessimistic about the economy and corporate profits.

The Fed plans to limit its support in the first month to purchases of $18 billion in Treasuries.

Corporations’ borrowing costs haven’t fallen as fast as Treasury yields, with the difference between companies’ rates and comparable government securities widening to 1.90 percentage point on Aug. 11 from 1.86 point on Aug. 9, according to Bank of America Merrill Lynch index data. For high-yield bonds, the premium widened to 6.78 percentage points from 6.54 points, the biggest gap since July 20.

Bond Sale

International Business Machines Corp., the world’s biggest computer-services provider, sold bonds with coupons at historic lows last week. The yield on those bonds rose 1 basis point to 1.03 percent on Aug. 11. A basis point is 0.01 percentage point.

While the Fed’s action may reduce mortgage costs, it won’t necessarily help the housing market. “It pushes rates lower, but it doesn’t change the reality for many would-be borrowers” who are worried about their jobs or lack money for a down payment, said Greg McBride, a senior financial analyst at Bankrate Inc. in North Palm Beach, Florida.

Mortgage rates for U.S. home loans set a record low for the eighth straight week, Freddie Mac, the home-finance provider, said yesterday. The average rate of a 30-year fixed-rate mortgage dropped to 4.44 percent in the week ended yesterday from 4.49 percent.

“The Fed is basically adding more money, but what’s needed right now is not more money,” said David Darst, the New York- based chief investment strategist at Morgan Stanley Smith Barney, which oversees $1.6 trillion. “What’s needed is more confidence, more animal spirits.”

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net; Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

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