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September 23, 2011

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Fed plans Treasury swap in a bid to stimulate US economy

THE US Federal Reserve will use more than US$400 billion to try to drive down long-term interest rates, make home and business loans cheaper and invigorate the US economy.

Analysts said the moves would provide only a slight economic benefit.

The action is modest compared with its previous steps. The Fed will not expand its holdings - it is just rebalancing them.

It will sell US$400 billion shorter-term Treasuries to buy longer-term Treasuries by June next year.

And it will reinvest principal payments from its mortgage-backed securities, to help keep mortgage rates at super-low levels.

The Fed announced the moves after a two-day meeting of its policymaking group - three of the group's 10 members dissented. The Fed acted despite criticism from Republicans who have warned that such steps could ignite inflation.

Josh Feinman, global chief economist at DB Advisors, said: "The actions the Fed has taken are helpful. They will help hold down long-term rates but they are no panacea."

The plan the Fed unveiled Wednesday, dubbed "Operation Twist," resembles a program the Fed used in the early 1960s to "twist" long-term rates lower relative to short-term rates.

In its statement, the Fed noted that the economy is growing slowly, unemployment is high and housing remains in a prolonged slump.

Under its plan, the Fed will extend the average maturity of its holdings from six to eight years. The Fed has directed the New York Fed to buy Treasuries with remaining maturities of six to 30 years, and to sell an equal amount of securities with maturities of three years or less.

Analysts said the shift in the Fed's portfolio could reduce borrowing costs and raise stock prices.

"This is a measured response to weak economic conditions," said David Jones, head of DMJ Advisors. "The Fed is still trying but it can only do so much."

In June, the Fed completed a US$600 billion bond-buying program that many economists have credited with keeping rates low.

Jones said market anticipation of the Fed's Operation Twist had sent long-term rates down by around 25 basis points for the 10-year bond. He said that without the Fed's latest move, those rates would have risen. With the move, he predicted the 10-year bond would probably fall by another 5 basis points.

The three members who dissented have said the Fed's policies raise the risk of high inflation. They favor giving the economy more time to heal without further Fed action.




 

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