A Fed to Be Reckoned With

Story Highlights:

• The Fed announced on Wednesday it will undertake three additional strategies to combat the economic downturn. Combined, the strategies will inject up to an additional $1.15 trillion into debt capital markets.
• In addition to increasing funding for existing lending programs, the Fed will purchase up to $300 billion in longer-term Treasuries over the next six months.
• Purchasing Treasuries puts the Fed closer in line with the quantitative easing undertaken by central banks in the UK and Japan. Indeed, quantitative easing appears to be gaining momentum globally.

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The Federal Open Market Committee (FOMC), led by Chairman Ben Bernanke, emerged from its scheduled meeting Wednesday with guns blazing. Contrary the meeting may yield little substantive action, the Fed announced three additional strategies to combat the economic downturn. Combined, the strategies will inject up to an additional $1.15 trillion into debt capital markets —a staggering amount.

The it will increase the Federal Reserve's balance sheet by purchasing up to an additional $750 billion of agency mortgage-backed securities (on top of $500 billion already pledged) and up to an additional $100 billion in agency debt (currently $100 billion is earmarked). In addition, the Fed will purchase up to $300 billion in longer-term Treasuries over the next six months in an effort to push down mortgage rates. This announcement pushed bond yields on 10-year US Treasuries down to 2.53%—a sharp 0.47% drop from the day prior.

Purchasing Treasuries puts the Fed closer in line with the quantitative easing undertaken by central banks in the UK and Japan. The Bank of England government bonds, or gilts, from investors in a reverse auction program earlier this month (targeting a total of £75 billion, or about $107 billion, over the next three months) and has seen yields on 10-year gilts subsequently sliding to record lows. The Bank of Japan recently of its outright monthly purchases of Japanese government bonds to 1.8 trillion yen ($18.3 billion).

Quantitative easing appears to be gaining momentum globally. In the US and around the world, central banks continue to look beyond traditional monetary policy tools (e.g., manipulating benchmark interest rates) to stimulate economies. This quickly infuses capital markets with a massive amount of liquidity and should continue to drive down lending rates and ease credit markets. Combined with new globally, this is unprecedented global stimulus.

Quantitative easing by the Fed was hinted at previously, though the amount announced today is simply astonishing. Quantitative easing isn't without risks. Besides inflation down the road, another worry is falling yields causing funds holding bonds (like pension funds) to appear underfunded. Firms sponsoring several underfunded pensions might have to cut into profits to compensate for the reduction. UK corporations are seeing signs of this happening, though the severity of the situation is likely overstated for now.

Still, the Fed's announcement of such a step means it is indeed employing all "available tools to promote economic recovery and to preserve price stability." And to naysayers claiming the Fed's out of ammunition, it proves the Fed's still a force to be reckoned with. This announcement is like a barrage of monetary Howitzer blasts.