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Fed Will Lengthen Maturity of Securities in Bid to Cut Rates

Fed Will Shift Treasury Holdings to Longer-Term Securities
Chairman Ben S. Bernanke expanded use of unconventional monetary tools for a second straight meeting after job gains stalled and the government lowered its estimate of second-quarter growth. Photographer: Brendan Smialowski/Bloomberg

The Federal Reserve will replace $400 billion of short-term debt in its portfolio with longer-term Treasuries in an effort to reduce borrowing costs further and counter rising risks of a recession.

The central bank will buy securities with maturities of six to 30 years through June while selling an equal amount of debt maturing in three years or less, the Federal Open Market Committee said today in Washington after a two-day meeting. The action “should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative,” the FOMC said.

Chairman Ben S. Bernanke expanded use of unconventional monetary tools for a second straight meeting after job gains stalled and the government lowered its estimate of second-quarter growth. Yields on 30-year Treasuries fell below 3 percent for the first time since 2009 and U.S. stocks had their biggest drop in a month on the Fed’s plan, dubbed “Operation Twist” after a similar Fed action in 1961.

“There are significant downside risks to the economic outlook, including strains in global financial markets,” the Fed statement said. By contrast, the August statement said only that downside risks had increased and omitted any mention of financial markets.

Boost to Growth

Today’s action may boost growth by 0.2 percentage point to 0.4 percentage point during the next year, said Keith Hembre, a former researcher at the Minneapolis Fed. Central bankers might have passed on a third round of net asset purchases because inflation is higher than it was when they began the second round of so-called quantitative easing in November, he said.

“The Fed, I think, is fairly constrained right now,” said Hembre, chief economist and investment strategist in Minneapolis at Nuveen Asset Management, which oversees about $210 billion. “The Fed can either do nothing, or it can do something like this.”

The Fed left unchanged its pledge to keep the benchmark interest rate near zero through at least mid-2013 as long as unemployment remains high and the inflation outlook stays “subdued.” The central bank has kept the target federal funds rate for overnight interbank loans in a range of zero to 0.25 percent since December 2008.

Policy makers amended the interest-rate pledge at their Aug. 9 meeting to substitute mid-2013 for the less-specific “extended period” that had been in FOMC statements since March 2009.

Mortgage Securities

The central bank said today it will also reinvest maturing housing debt into mortgage-backed securities instead of Treasuries “to help support conditions in mortgage markets.”

Yields on Fannie Mae and Freddie Mac mortgage securities that guide U.S. home-loan rates tumbled the most in more than two years relative to Treasuries. The average rate on a typical 30-year fixed loan fell to a record low 4.09 percent last week.

The FOMC vote was 7-3. Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota and Charles Plosser of the Philadelphia Fed voted against the FOMC decision for a second consecutive meeting. They “did not support additional policy accommodation at this time,” the Fed statement said today.

Average Maturity

The amount of debt to be sold represents about three-fourths of Fed holdings of between three months and three years. The central bank will release a schedule of purchases and sales for October on Sept. 30. The program will extend the average maturity of the Fed’s Treasury holdings to 100 months, or 8 1/3 years, by the end of 2012, from 75 months.

“In response to the lower Treasury yields, interest rates on a range of instruments including home mortgages, corporate bonds and loans to households and businesses will also likely be lower,” the Fed said on its website.

The Standard & Poor’s 500 Index fell 2.9 percent to 1,166.76 in New York. The yield on the 10-year Treasury note closed down eight basis points, at 1.86 percent, after touching a record low of 1.85 percent. Yields on 30-year bonds tumbled 21 basis points to 2.99 percent.

“Bernanke would rather try and fail than never have tried at all,” said Diane Swonk, chief economist for Mesirow Financial Inc. in Chicago. “He does have a mandate to deal with, and even if this helps on the margin, that makes a difference for an economy that’s growing on the margin.”

Inflation View

Inflation “appears to have moderated since earlier in the year,” the Fed said today without citing a specific measure. The Fed’s preferred price gauge, which excludes food and energy costs, rose 1.6 percent in July from a year earlier, accelerating from a 1 percent gain in March. At the same time, retail gasoline prices have declined to an average of $3.57 a gallon from $3.99 in May.

“This could be regarded as a bold move, as this hasn’t been used for many years,” said K. C. Chan, acting financial secretary of Hong Kong, where monetary decisions track those of the Fed because of a currency peg to the dollar. “This could ease strains in financial markets and help keep up economic momentum,” Chan told reporters today in Hong Kong, referring to the Fed’s announcement.

The Fed’s System Open Market Account held $2.64 trillion in securities as of Sept. 14, which included $1.65 trillion in Treasury notes, bills and inflation-protected bonds and $995 billion of mortgage debt.

Two Rounds

The central bank purchased $2.3 trillion in debt from December 2008 through June in two rounds of so-called quantitative easing aimed at lowering borrowing costs for companies and consumers with the benchmark interest rate already at zero.

Of the Fed’s $1.56 trillion in Treasury notes, 19 percent mature in less than two years; 35 percent have maturities of two to five years; 36 percent are due in five to 10 years; and 10 percent mature in 10 to 30 years, according to Bloomberg calculations based on New York Fed data.

Economists surveyed by Bloomberg anticipated a Fed program today to extend the duration of its Treasuries. Of 42 surveyed analysts, 71 percent forecast such a move, even as 61 percent said it would probably fail to reduce unemployment.

“This is not likely to provide any significant stimulus,” said Jason Schenker, president of Prestige Economics LLC in Austin, Texas. “The market really needed a boost of confidence. There is no confidence from this.”

Chubby Checker

The Operation Twist from 1961, conducted with the Treasury Department, got its name from Chubby Checker’s hit song, “The Twist,” according to a report published March 14 by Eric Swanson, an economist at the Federal Reserve Bank of San Francisco. That move lowered long-term Treasury yields by about 15 basis points, or 0.15 percentage point, according to Swanson.

Bernanke and his colleagues, who have a dual congressional mandate to achieve stable prices and maximum employment, are trying to reduce 9.1 percent joblessness that’s crept up 0.3 point since March. It reached a 26-year high of 10.1 percent in October 2009.

The U.S. economy expanded at a 1 percent annual pace in the second quarter, the government said Aug. 26, reducing the initial 1.3 percent estimate. Growth may be accelerating to 1.8 percent in the third period, according to the median estimate of 66 economists surveyed by Bloomberg News from Sept. 2 to Sept. 7. The International Monetary Fund yesterday cut its U.S. growth projection for 2011 to 1.5 percent from 2.5 percent in June.

Unemployment Outlook

The pace isn’t fast enough to make much of a dent in joblessness, analysts say. The unemployment rate won’t budge from 9.1 percent for the rest of the year, based on the median estimate of economists in the Bloomberg survey; it will reach 8.7 percent in the fourth quarter of 2012, respondents said.

Last year’s $600 billion of bond buying brought the Fed in for the strongest political criticism in three decades as Republicans, including Ohio Representative John Boehner, now the House speaker, said the central bank’s actions risked depreciating the dollar and causing too much inflation.

Republican lawmakers including Boehner and Senate Minority Leader Mitch McConnell urged Bernanke in a letter this week to refrain from additional monetary easing to avoid “further harm” to the economy.

The barbs have extended to the Republican campaign for the 2012 presidential nomination, with Texas Governor Rick Perry saying Aug. 15 that Bernanke would be treated “pretty ugly down in Texas” if he printed more money before the election.

Today’s move, while short of creating money, brought criticism from both sides of the political aisle.

Republican Senator David Vitter of Louisiana said the program is more likely to backfire by fueling inflation and devaluing the dollar.

Vermont Senator Bernard Sanders, an independent who caucuses with Democrats, said the action is “not bold and will not create the millions of jobs that America needs.”

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