Fed keeps low interest rates

Decision encourages borrowers, but payouts will suffer


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Financial markets rallied Thursday after the Federal Reserve Board said it intends to keep long-term interest rates low until the jobs market improves.

The Fed now expects to keep short-term interest rates at record low levels through at least mid-2015, six months longer than previously anticipated. The central bank also announced a third round of quantitative easing, saying it will purchase about $40 billion a month in additional government-backed mortgage bonds to keep rates on mortgages and other long-term loans low.

The Fed said that if the labor picture does not improve substantially, it will continue purchasing the mortgage securities until the outlook improves, as long as the purchases do not spark inflation.

The news cheered Wall Street and borrowers, but was jeered by those who rely on interest payments from savings accounts and fixed-income investments.

Stocks and other riskier investments that are more attractive in a low-interest rate environment spiked after the Fed's 12:30 p.m. statement.

The S&P 500 index, a broad measure of the stock market's health, finished Thursday at 1,459.99, up 23.43 or 1.6 percent. That's the highest since the last day of 2007, but about 7 percent below the all-time high of 1,565, set in October 2007.

The Dow Jones industrial average also gained 1.6 percent, closing at 13,539.86, up 206.5, while the Nasdaq composite index finished at 3,155.83, up 41.52 or 1.3 percent.

Yields on 10-year Treasuries fell, sending bond prices higher. Gold rose 2 percent, finishing at $1,765, up $34.

"It's a confidence boosting measure for the markets, a risk-on signal," said Paul Edelstein of IHS Global Insight, an economics research firm.

Market pundits said investors' reaction could boost Democratic President Barack Obama's re-election bid. Republican presidential candidate Mitt Romney has said he would not reappoint Mr. Bernanke, whose term expires in 2014.

"It certainly is going to get a lot of attention as a blatantly political act," said Charlie Smith, chief investment officer of Fort Pitt Capital in Green Tree.

Many analysts and investors had anticipated both measures, based on the Fed's statement after its last meeting, which ended Aug. 1, and on Mr. Bernanke's Aug. 31 speech at the Kansas City branch of the Fed's annual Jackson Hole, Wyo., conference.

At the Jackson Hole conference, Mr. Bernanke expressed concern about persistently high unemployment, which was underscored by last week's jobless figures.

The U.S. economy created just 96,000 jobs in August, well below the 139,000 monthly average this year. The drop in the unemployment rate to 8.1 percent was linked to more workers giving up looking for a job. The so-called "discouraged" workers are not reflected in the unemployment rate, which would be considerably higher if they were.

The Fed's commitment to keep purchasing long-term government-backed mortgages until the jobs market improves captured the attention of analysts.

"I was surprised by the open-endedness of this measure," Mr. Smith said. "It is a significant incremental change."

Joseph Balestrino of Federated Investors, Downtown, compared it to the European Central Bank's commitment last week to purchase government securities to support struggling economies in the European Economic Community.

"It's going to do whatever it takes and it's going to take a lot," said Mr. Balestrino, Federated's chief fixed-income market strategist.

But he and other analysts questioned whether low interest rates will be able to spark economic growth, particularly in housing, where depressed home prices and stricter loan requirements are preventing new buyers from purchasing and existing homeowners from refinancing.

"Even if the Fed pushed mortgage rates down from current historic lows, the impact on [economic] growth and unemployment would probably be imperceptible," Mr. Edelstein said.

The Fed said that if it did not act, "economic growth may not be strong enough to generate sustained improvement in labor market conditions."

The Fed forecast the U.S. economy will grow 1.7 percent to 2 percent this year vs. the range of 1.9 percent to 2.4 percent forecast in June. It raised its 2013 and 2014 forecasts, which surprised Mr. Edelstein.

"They got more optimistic and decided to do more heavy easing at the same time. The only thing we can say is that they have some heroic confidence in these measures," he said.

The Fed forecast unemployment will not fall below 8 percent this year and predicted a jobless rate of 7.6 percent to 7.9 percent next year. It expects inflation to range between 1.6 percent to 2 percent through 2015.

The statement indicated the Fed could keep short-term rates low even after the economy strengthens. Analysts said that sounds like the Fed, which wants to keep inflation at about 2 percent, may tolerate something a little higher.

A prolonged bout of record low interest rates has not discouraged those drawing paltry interest checks on their bank deposits. Federally insured U.S. banks and thrifts had $10.3 trillion in deposits as of June 30, up 5.7 percent from a year ago and up 20.4 percent from four years ago, according to SNL Financial. Both increases outpaced the growth in loans made by the same institutions, the Charlottesville, Va., research firm said Thursday.

Mr. Balestrino questioned whether extending the commitment to keep short-term rates low into 2015 will spark lending. He said what the move will do is make stocks and other investments that could help the economy grow more attractive.

"At some point, the drug doesn't work any more," Mr. Balestrino said. "I think he's trying to get all government [securities] rates so low that we won't buy them."

businessnews

Len Boselovic: lboselovic@post-gazette.com or 412-263-1941. First Published September 14, 2012 4:00 AM


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