There was hardly any suspense before the Federal Reserve announced Wednesday that it will keep its target rate for federal funds at historic lows Wednesday, but the central bank made it appear likely that it will extend its easy-money policy to purchasing long-term Treasury bonds.
This would mean the Fed is fighting to keep interest rates low by printing up money, an unusual strategy meant to promote economic growth. The potential cost of that policy is inflation, but right now the central bankers are concerned only with deflation.
In December, the Fed's policy setting Federal Open Market Committee noted the continuing deterioration of labor markets and shaky outlook for the U.S. economy. With thousands more layoffs announced this week alone, it came as no surprise that the central bank saw even worse econmic conditions leading up to its January meeting, including a threat of deflation.
After noting diminished pricing pressures for several months, the central bank said it expects inflation to remain subdued in coming quarters, and for the first time in the current economic downturn suggested it may "persist below rates that best foster economic growth and price stability."
Earlier Wednesday, the International Monetary Fund slashed its global 2009 GDP forecast to 0.5%, from 2.2%, essentially predicting the world's economy will slow to a crawl this year. IMF financial advisers counseled clearing toxic assets off bank balance sheets as a key, but acknowledged the difficult in valuing such assets.
The Fed did not announce any new stimulus measures, but said it is prepared to expand purchases of agency debt and mortgage-backed securities and the purchase longer-term Treasury securities. Only Richmond Fed President Jeffrey Lacker dissented from Wednesday's action, preferring an immediate expansion of the monetary base through Treasury purchase, rather than the wait-and-see attitude other members preferred.
The remarks come after the Fed said it was evaluating the benefits of Treasury purchases at its Dec. 16 meeting. At that gathering, the central bank slashed its federal funds rate to a target range between zero and 0.25%, and said it anticipates the target will remain at low levels for some time, an expectation that was echoed in Wednesday's statement. (See"Fed On Easy Street.")
Treasury yields were creeping higher Wednesday before the Fed's statement, with the 10-year note returning 2.61%, up from 2.52% Tuesday. Substantial bond purchases by the Fed would put downward pressure on yields, helping sop up some of the massive supply resulting from the government's bailout programs, prodding investment in corporate debt and other asset classes, like stocks, that offer higher returns.
The iShares Barclays 7-10 Year Treasury Bond Fund (nyse:IEF - news - people ), an exchange-traded fund that tracks a range of intermediate maturities, was down 0.6% Wednesday, reflecting rising interest rates. The session was mixed though, as the ProShares UltraShort Lehman 7-10 Year Treasury(nyse: PST - news - people ) ETF, which seeks returns that double the inverse performance of a range of bonds, gained 0.6%.
Wall Street stocks were trading higher, as investors eyed the central bank's report and cheered the possible creation of a government-backed "bad bank" that would either take over or backstop the toxic mortgage-related assets that are weighing on financial firms. The Dow Jones industrial average, was up 173 points, or 2.1%, to 8,348 shortly after the Fed's statement; while the S&P 500 gained 26 points, or 3.1%, to 872; and the Nasdaq added 53 points, or 3.6%, to 1,558. (See "Bad Bank = Good News.")
