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USD dollar note -as good as wallpaper? And US, the beggining of the end ?

Fed to Buy $300 Billion of Longer-Term Treasuries (Update4)
By Craig Torres

March 18 (Bloomberg) -- The Federal Reserve opened a new front in its battle to bring down borrowing costs across the economy, pledging to buy as much as $300 billion of Treasuries and stepping up purchases of mortgage bonds.

The announcement following the Federal Open Market Committee meeting today in Washington spurred the biggest rally in longer-dated Treasuries in decades. Officials unanimously voted to expand the Fed’s balance sheet up to $1.15 trillion, and said they may broaden a program aimed at boosting consumer loans to include other assets, today’s statement showed.

With today’s move, the Fed has committed to buy or loan against everything from corporate debt, mortgages and consumer loans to government debt, after cutting its benchmark interest rate to zero failed to end the credit crunch. The unprecedented campaign comes after a worsening recession sent the unemployment rate up to a quarter-century high of 8.1 percent.

“The FOMC may believe the economy is nowhere near a bottom,” William Poole, former president of the St. Louis Fed, said in an interview today with Bloomberg News. “The Fed is engaging in a massive quantitative easing.”

Quantitative easing refers to using injections of funds into the economy as the main policy tool. Poole is now a senior economic adviser to Merk Investments LLC in Palo Alto, California, and a contributor to Bloomberg News.

Yields Plunge

Benchmark 10-year note yields plunged to 2.48 percent at 4:40 p.m. in New York, from 3.01 percent late yesterday, the biggest decline since records dating from 1962. The Standard & Poor’s 500 Stock Index rose 2.1 percent to 794.35 at the close.

“They wanted to shock the market and they succeeded,” said Ajay Rajadhyaksha, the head of fixed-income strategy at Barclays Capital in New York. If the Fed’s action “succeeds in driving primary mortgage rates” to about 4.25 percent to 4.5 percent, that would increase “affordability, which will in turn lead to increased housing demand.”

Central banks around the world are grappling with how to formulate policy with target interest rates near zero. The Bank of England is buying government bonds and corporate debt, the Bank of Japan is snapping up government notes and making subordinated loans to banks, and the Swiss National Bank is intervening to weaken the franc.

Chairman Ben S. Bernanke is employing strategies to stamp out the risk of deflation that he first laid out as a Fed governor in 2002, when he listed purchases of longer-dated Treasuries as an option.

Inflation Subdued

While buying government debt has, in some historical episodes, been associated with causing inflation to soar, Fed officials are confident that consumer prices will remain in check given “weak” demand.

The FOMC said today that inflation could “persist for a time” below their preferred level. A government report today showed that consumer prices, excluding food and energy costs, rose 1.8 percent in February from a year before, compared with an average rate of 2.2 percent over the past decade.

Bernanke is trying to prevent the credit contraction from deepening what already may be the worst recession in 60 years. U.S. employers have eliminated 4.4 million jobs since the start of last year. Industrial production fell 1.4 percent in February, the fourth consecutive decline, while factory capacity in use hit 70.9 percent, matching the lowest level on record.

‘Gradual Resumption’

“Information received since the Federal Open Market Committee met in January indicates that the economy continues to contract,” the FOMC said in the statement. “The committee anticipates that policy actions to stabilize financial markets and institutions, together with fiscal and monetary stimulus, will contribute to a gradual resumption of sustainable economic growth.”

The global economy will contract this year for the first time since World War II, the World Bank predicts, forcing central banks to keep pumping money into their economies when conventional interest rates are at, or close to, zero.

The Fed has cut the benchmark rate from 5.25 percent, beginning in September 2007, as credit froze and the economy buckled. Policy makers are now focused on how to further channel money to the economy. The Fed has already committed to buying $600 billion of mortgage-backed securities and bonds sold by government-sponsored housing agencies.

Geithner Plans

Treasury Secretary Timothy Geithner also may unveil details in coming days on his plans to remove distressed mortgage assets from banks balance sheets. People familiar with the matter said the effort will involve expanding the Fed’s Term Asset-Backed Securities Loan Facility to include lower-rated, illiquid assets in addition to recent, top-rated debt backed by consumer loans.

The Federal Deposit Insurance Corp. may also get a broader role in the Obama administration’s strategy, the people said. The Treasury may make its announcement as soon as this week.

While the Fed’s actions have helped bring down mortgage rates, those costs have remained elevated relative to benchmark Treasuries. Prior to today’s meeting, the difference between rates on 30-year fixed mortgages and 10-year Treasuries was 2.1 percentage points, Bloomberg data show. That’s up from an average of 1.75 percentage points in the decade before the subprime mortgage market collapsed.

Yields on Fannie Mae’s 4.5 percent mortgage securities fell 0.27 percentage points from yesterday to 3.97 percent as of 3:30 p.m. in New York, suggesting new-loan rates may be pushed down about 0.27 percentage point, according to data complied by Bloomberg. Thirty-year fixed-rate mortgages averaged 5.03 percent as of March 12.

Types of Treasuries

The central bank will begin purchases of longer-term Treasuries “late next week” and buy the securities two to three times per week, the New York Fed, which will manage the operation, said in a statement. The transactions will be concentrated in two-year to 10-year debt the statement said; 30- year bonds underperformed 10-year notes as a result.

Through emergency loans and liquidity backstops, U.S. central bankers have expanded Fed credit to the economy by an unprecedented $1 trillion over the past year.

Banks worldwide have posted $1.2 trillion in write downs and credit losses on mortgage loans and other assets. U.S. Treasury officials will put the largest 19 banks through “stress tests” and decide whether they need more capital. The banks can raise equity privately or seek more government funds. Officials are also looking at ways to remove bad assets.

Coca-Cola Co., health insurer WellPoint Inc. and more than 30 other companies are tapping longer-term credit markets and paying down their short-term IOUs, a sign of some investor confidence.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net.

Last Updated: March 18, 2009 16:51 EDT