Thursday, January 15, 2009

Fed Strategy Is a Blast From the Past

By DEBORAH LYNN BLUMBERG The Federal Reserve is considering purchases of longer-dated Treasurys as a way to assist the economy through lower rates. But, for now, it's likely to hold off on the move. Instead, the central bank will let its other cash-pumping programs run their course for a while, particularly as its efforts have been successful in lowering mortgage rates, key to an eventual economic recovery. It also has one more program left to launch, the plan to purchase securities backed by consumer loans, which should further ease borrowing costs. Treasury buying "is unlikely now," said Brian Fabbri, chief North American economist at BNP Paribas in New York, given the Fed's current goal of lowering borrowing rates. "The most direct way to accomplish that is to buy mortgage paper and to buy commercial paper," Mr. Fabbri said, "and then, if that doesn't work, to buy Treasurys." The Fed most recently bought longer-term Treasurys in the 1960s in an effort to help the economy recover from a recession. In the so-called Operation Twist, the Fed attempted to twist, or flatten out, the yield curve by buying long-term government debt, to stimulate borrowing and business investment; and selling short-term bills, to keep foreign investors' interest in government debt alive. The key difference: Rates weren't close to zero then. And the policy's success remains a matter of debate. This time around, policymakers began late last year to mention possible longer-end Treasury buying as a tool at their disposal, given that rates are at the zero bound. This week, Fed officials, including Chairman Ben Bernanke and several regional Fed presidents, have raised the possibility. The Fed already has had measurable success in driving down mortgage rates without buying Treasurys. Its program to buy $500 billion in mortgage-backed securities has succeeded in pushing home loan rates to near record lows. The 30-year fixed mortgage rate this week is around 5.08%, according to, from just above 6% on Nov. 27, when the Fed announced its program. Just by discussing the possibility of buying longer-dated Treasurys, the Fed is keeping a lid on yields on the long end. Wednesday, the benchmark 10-year Treasury yield was at 2.194%, down from Tuesday's 2.301%, with the price up 26/32 point, or $8.125 for every $1,000 invested. The 30-year bond yield was at 2.896%. Corporate Defaults Expected to Climb Corporate defaults are likely to reach their highest level in more than 20 years as the global financial crisis continues and companies try to survive the most difficult economic conditions since the Great Depression, Moody's Investors Service said. The global default rate for speculative grade, or junk, companies is expected to climb to 15.1% by the end of 2009, more than triple the current rate of 4.0%, according to the ratings firm. Moody's expects the U.S. speculative-grade default rate to reach 15.3%. In December, Moody's predicted the 2009 default rate would top out at 10.4%. The ratings agency, however, said it was forced to revise that estimate based on worsening economic indicators that surpass anything seen during the downturns in 2001 and 1991. —Rachel Feintzeig

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