“There are significant downside risks to the economic outlook, including strains in global financial markets,” the Fed said in a bid to justify its latest intervention. The Fed will buy $400bn (£253.bn) long-term Treasury securities by the end of June next year, funded by selling the same amount in short-term paper.
It hopes the move will weigh down interest rates, boosting borrowing and demand in the economy.
The struggling US housing market will also be targeted by the Fed, which announced a second “twist” -- recycling money from its maturing mortgage and housing agency bonds back into the mortgage market. Prices in the market for mortgage-backed securities (MBS) spiked on the news.
The stock market in New York took a hit following the Fed’s gloomy outlook, and its refusal to kick off a third round of quantitative easing (QE3).
The Dow Jones closed down 2.5 per cent while the Nasdaq lost two per cent – mainly in afternoon trading.
The downbeat verdict also hit oil prices; Brent crude for November delivery fell 18 cents a barrel to settle at $110.36, after topping $112 earlier.
Yet some analysts see the Fed gearing up to QE3. “The doves still seem to have a working majority for further action. As long as that remains the case then QE stands a chance of being introduced as early as the November meeting,” said ING’s Rob Carnell.
The Fed’s three hawkish dissenters continued to oppose the new accomodative measures; Richard Fisher, Narayana Kocherlakota and Charles Plosser all voted against the twist.
Yet six of the Fed’s senior officials rallied behind chairman Ben Bernanke in support of the policy.
Despite the scheme being widely expected, yields on government bonds sank on the news – perhaps due to expectations that the size of the twist would be smaller than the announced $400bn.
Yields on 10-year notes dropped to 1.856 per cent, the lowest in more than 60 years -- a dip of 3.8 per cent during the day. Yields on 30-year notes also fell off a cliff, falling from over 3.2 per cent to below three per cent, in the aftermath of the statement.
Nearly a third (29 per cent) of the Fed’s intended purchases will be in the 20- to 30-year area, while the remaining Treasury securities will have six to 10 years left to mature.
“We doubt this latest action will accomplish anything,” said Paul Ashworth of Capital Economics. “The cost of borrowing simply isn’t the problem. Businesses don’t have the confidence to invest and half of all mortgage borrowers don’t have the home equity needed to refinance at lower rates.”