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Thursday, March 19, 2009

Fed goes all-in

The Federal Reserve, unable to really lower rates anymore with the effective borrowing rate near zero, continues to resort to other means to reduce credit problems within the system.  They intend to purchase another 750 bil of mortgage backed securities.  Presumably this suggests they’ve already bought the 500 billion they had previously committed to purchase.  Commensurate with this announcement, they said they would purchase 300 billion of long-term treasuries over the next 6 months.  It’s a 1 trillion dollar intervention in one swoop.

China, the largest holder of our bonds, has warned recently that the administration had better keep the currency firm or they will be forced to sell.  Theoretically, by buying the long end, the Fed will keep China’s investment somewhat stable.  The dollar, on the other hand, dropped significantly.  Inflation sensitive commodities have exploded, with gold and crude oil trading up over 6% since the announcement.  Outright purchase of the long bond was perceived to be the Fed’s move of last resort and its a bit surprising to see them use it when markets have been clearly recovering.  The Fed minutes will be interesting when they are released in a few weeks.

The Fed views deflation as one of the larger near-term risks in the economy.  The problem with engineering inflation is its hard to stop once you get it going.  They’ve got so much stimulus coming at the economy from so many different directions -- there’s lots of options to throttle back if they need to.  Conventional wisdom dictates when there is too much debt in the system, the currency must be inflated to make that debt easier to pay off.

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