The US Federal Reserve has taken a tiny step to boost the US economy, but it was also a big step in terms of policy switch.
The Fed said in its post meeting statement that it will use money from its investments in mortgage securities to buy government debt on a small scale.
In other words it won’t allow its balance sheet, currently around $US2.3 trillion, to contract as existing investments mature; the money will be reinvested.
The aim is to try and cut already weakening long-term rates on mortgages and corporate debt.
But that won’t have an impact on stimulating economic growth.
Corporate borrowing rates have fallen sharply (IBM did a big three year issue recently at 1%) and mortgage rates are at record lows, but with not much in the way of demand for new loans, although there is some refinancing going on.
Economists say it is a largely symbolic action that tells us the Fed sees the recovery weakening and that it is ready to take more aggressive action, if needed, to keep it on track.
In fact the Fed changed the tone in its post meeting statement to reflect this new caution.
It said it now believes economic growth will be "more modest" than it had anticipated at its late June meeting.
“The pace of economic recovery is likely to be more modest in the near term than had been anticipated,” the Federal Open Market Committee said in the statement.
“To help support the economic recovery in a context of price stability, the Committee will keep constant the Federal Reserve’s holdings of securities at their current level.”
The Fed, citing "subdued" inflation, said it would keep its target for a key interest rate at zero to 0.25 per cent for an "extended period".
The yield on the Treasury’s 10-year bond fell to 2.77% from 2.82% just before the announcement.
The Fed said it will “continue to roll over the Federal Reserve’s holdings of Treasury securities as they mature.”
The reinvestment policy applies to agency debt and agency mortgage- backed securities held by the central bank.
“The pace of recovery in output and employment has slowed in recent months,” the Fed said. The Fed will “continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability.”
Economists had expected the Fed to reveal some plan to boost the financing of the slowing US economy to ward off a dose of deflation or a double dip recession.
The rising level of concern over the slowing pace of growth, falling home sales and construction, subdued consumer spending and retail sales, not to mention the depressed jobs market, has got more and more analysts, investors and ordinary Americans fearing another recession.
That’s not on the cards, but a slump in the level of growth and general activity is.
Even if the economy was still growing at a moderate pace (as the Fed had it in June), there would still be a sharp fall-off in activity in the 4th quarter of the year simply because the same quarter of last year saw growth at an annual 5.6%.
But since the last Fed meeting we now know that the size of the recession was bigger than previously thought, a fall of 4.1% in the level of activity from the end of 2007 to midway through 2009, compared with the previous forecast of 3.7%.
And the labour market is getting more depressed (as is housing).
A million people left the labour market from April through June because they were despondent at not being able to find jobs.
If they were still in the labour force, the US unemployment rate in July would have been around 10.4%.
Profit growth among big companies remains solid, as the second quarter is revealing, but consumer spending is falling (driven by falls in consumer credit), house foreclosures remain high and starts are at close to record lows.
Deflation remains a concern as consumer and producer prices edge lower.
But soaring grain, coffee, cocoa (chocolate), meat and orange juice prices might help stabilise price pressures around the annual 1%-2% a year, instead of under 1% and dipping, as it has been for the past three months.
Gross domestic product grew at a 2.4% annual rate in the second quarter, down from a 3.7% rate in the first three months of the year and the 5.6% in the December quarter of 2009.
The US labour market seems stuck in second gear with the private sector adding fewer than 100,000 jobs per month since May.
It needs to create around 125%, just to stand still so far as the unemployment rate is concerned.
Last month Federal Reserve Board Chairman Ben Bernanke stressed the central bank was "ready" to take further steps to stimulate the US economy if growth turns out to be weaker than expected.
"We are ready and we will act if the economy does not continue to improve — if we don’t see the kind of improvements in the labor market that we are hoping for and expecting," Bernanke told Congress.
Bernanke listed the options he said that the Fed is open to considering.
The first option would be to signal to markets that rates are on hold for a very long "extended period".
The second would be to reduce the interest rate on excess reserves. And the final option would be adjusting the balance sheet by not letting maturing housing-related securities run off.
