Yesterday the Fed announced it would buy as much as $300 billion in longer Treasury bonds (2-10 years and perhaps as long as 30 years) plus another $850 billion of mortgage securities in order to bring down rates at the far end of the yield curve and thus make borrowing cheaper for mortgage seekers and corporations looking to issue debt.
This is very unusual, as the Fed does not normally venture out beyond the immediate area of its purview, i.e. money market instruments with maturity of up to 12 months. There are two reasons it is doing so:
- The inverse of the Greenspan conundrum: long rates are stubbornly high despite near zero short rates. The spread between 10-year Treasurys and Fed funds is near record levels (see chart below, click to enlarge). The Fed wants to lower long rates so that household mortgage and corporate borrowing costs come down and the economy gets to carry a lighter debt-service burden. Refinancing is going to be a booming business for quite a while, I think.
- The Fed wants to replace "private" money destroyed by loan defaults with "public" money it creates itself, effectively out of thin air and at will. Mr. Bernanke has explicitly stated that he will use every tool at his disposal to avert further deflation in the economy and he means to be taken at his word.
My bottom line, for market purposes? The same: Don't fight the Fed.