The Fed's Sterilization Plan: The Ticker

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By Caroline Baum

According to The Wall Street Journal's John Hilsenrath, the Federal Reserve is considering "sterilized" bond buying. In central-banker-speak, a sterilized open-market operation is one in which the new money created by purchasing notes or bonds is canceled out by an offsetting sale. In other words, there is no effect on the money supply.

The objective of any Fed bond-buying operation, sterilized or not, is to drive down long-term interest rates, encourage more risk-taking, and increase consumer spending and business investment, Hilsenrath writes.

Ever since its Jan. 25 announcement that it intends to hold the benchmark rate near zero through the end of 2014, the Fed has sounded as if it has a few screws loose. Obsessed, is more like it. The history of the last four years suggests the Fed will do whatever it takes to prevent an economic collapse. We know and understand this. Really we do.

So what's the deal? Surely a 3.9 percent 30-year mortgage rate isn't deterring anyone from buying a home. Nor are corporate bond yields too onerous for companies to borrow and invest.

I suspect the Fed is being preemptive. With higher gas prices expected to produce a 0.4 percent increase in the February consumer price index, which is reported later this month, the Fed wants to ensure that the news doesn't get reflected in higher bond yields.

Just in case traders or investors were thinking about bond sales, the Fed in effect left what traders call a "good-till-cancelled market order" to buy bonds. The urge to sell would be dramatically reduced by assurances from the Fed that it will be as preemptive in the other direction: when it comes time to raise rates.

(Caroline Baum is a Bloomberg View columnist. Follow her on Twitter.)

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-0- Mar/07/2012 20:09 GMT