- MARKETS
- DECEMBER 9, 2010
Markets Defy Fed's Bond-Buying Push
By JON HILSENRATH And MARK WHITEHOUSE
The Federal Reserve's decision to spur the economy with a $600 billion round of bond buying was among the most controversial in its history.
Jon Hilsenrath discusses why the Fed's new stimulus efforts have failed to lower long-term interest rates in the six weeks since the plan was officially begun.
Fed officials quarreled over whether to proceed. At worst, some members argued, such a move risked whipping inflation to dangerous levels.
Six weeks later, the bond program looks more like a water pistol than a cannon—and the reasons explain the immense and strange challenges of steering monetary policy in the aftermath of a financial crisis when short-term interest rates are already near zero.
The purchases of government bonds are meant to drive down long-term interest rates, which did happen in the lead-up to the Nov. 3 move. But since then, long-term rates are up sharply.
As Fed officials prepare to assess the program next Tuesday, they confront the latest counterweight to their interest-rate plan: the tax agreement between congressional Republicans and the White House that would extend Bush-era cuts and reduce payroll taxes. This has sent bond yields higher, not lower, by leading investors to expect more growth and inflation and to fret more about budget deficits.
The bond purchases were also expected to result in a weaker dollar, which proponents said would boost U.S. exports and which critics warned was inflationary. Confounding both camps, the dollar, after an initial fall, has risen.
The stock market has rallied, as Fed officials expected. Yet whether households are heartened by that is questionable.
Larry Stewart, a retired oil executive in Vienna, Va., says a 15% gain in his stock portfolio since late August, when the Fed broached the bond-buying idea, has given him little added confidence. Because of worries about his savings, Mr. Stewart says he is holding off on buying a new smart phone he wants and is cleaning his own house instead of paying a cleaner. "I still worry about having to dip into cash reserves to cover my living expenses," he said.
His concerns speak to broader obstacles standing in the way of the central bank. Its hope is that its purchase of Treasury notes and bonds will drive their prices up and send interest rates, which move in the opposite direction, downward—thus spurring both consumer spending and business investment.
Critics of the plan doubted it would work and warned it could fuel a speculative asset bubble in addition to inflation. But the early results suggest another outcome: The program might produce neither the burst in growth that officials so desperately want nor the inflation their critics so vociferously fear.
Federal Reserve Chairman Ben Bernanke, pictured at a Korea conference six weeks ago, pushed for a bond-purchase plan to drive down long-term interest rates; so far its effects have been only modestly helpful.
"The effect of the [bond buying] program itself is small enough that it is easily swamped by the bigger news from Europe over the last month as well as the political challenges that the program seems to have run up against." said James Hamilton, a professor at the University of California of San Diego.
In October, Mr. Hamilton estimated the program would keep long-term interest rates 0.2 percentage points lower than they would otherwise be. Today, he says the impact is probably a bit less than even that.
Fed officials have had modest expectations themselves. In what has become a common refrain, Vice Chairwoman Janet Yellen said in a mid-November interview, "I don't think this is a panacea."
On Tuesday, at their final policy meeting of the year, Fed officials are likely to leave the program unchanged. It calls for the Fed to buy $600 billion of bonds through next June, plus perhaps $300 billion more by reinvesting funds received as bonds from an earlier program mature.
The challenge the Fed faces is clear: The economy grew at an annualized rate of just 2.1% from the end of March through September, leaving unemployment stubbornly high.
Mixed Signals
Economic data have been looking better of late, with gains in consumer confidence, retail sales and some manufacturing indexes. To the extent that these improvements—or the stimulative result that could result from the new tax plan—are blocking the Fed's quest for lower rates, it's hard to complain.
A Federal Reserve Bank of Boston study estimates that through 2012 the bond purchases will result in 700,000 jobs that wouldn't otherwise be created, a big number, yet a fraction of the 8.3 million jobs wiped out in the recession. In a December Wall Street Journal survey of private economists, 42 of 52 called the estimate too optimistic.
The effort to spur spending and investment is constrained by fragile confidence and a hangover of the earlier debt boom.
At Ford Motor Co., "We've got to get debt down," Neil Schloss, the company's treasurer, said in an interview last week. Although Ford's car-finance unit tapped bond markets in September as interest rates fell—and although Ford on Thursday said it would invest $600 million in a Louisville plant—executives are averse to doing much borrowing because they want to win back an investment-grade credit rating. Ford's overall borrowing is down by $15 billion from a year ago.
While companies are grabbing cheap credit, many are investing and hiring outside the U.S. Chemical company Huntsman Corp. leapt at the chance to refinance $530 million of long-term debt in September and November. This reduced interest costs and pushed out repayment dates, helping Huntsman to invest in its business, according to its chief financial officer, Kimo Esplin. But the Texas company's biggest investment plans, which could result in roughly $400 million of spending in 2011, are for fast-growing economies in Asia. "Companies like Huntsman have easy access to capital markets, but they're taking that capital and they're funding growth outside the U.S.," Mr. Esplin said.
Around midyear, Fed Chairman Ben Bernanke began to lay the groundwork for bond purchases as he grew impatient with scant progress on growth and jobs, and with what appeared to be a deceleration of inflation. (Too much of a deceleration makes it harder to achieve low "real" interest rates—that is, rates adjusted for inflation—and could lead to outright deflation.)
In normal times, the Fed spurs the economy by moving short-term interest rates down, but it had already pushed those close to zero. Moving longer-term interest rates is a challenge, because they are determined by markets, which respond to a number of influences including expectations about future inflation and budget deficits.
The Fed first launched a bond-buying attack on long-term rates in the depths of the financial crisis. This first round of so-called quantitative easing ended in March. After Mr. Bernanke signaled in late August that a new round was coming, long-term rates began falling in anticipation. The average rate on prime 30-year mortgages stood at 4.36% the day before Mr. Bernanke sent the signal. It got as low as 4.17% in October.
John Donnelly was a beneficiary—and so was a car dealer. On Oct. 12, the retired sales manager in West Hartford, Conn., locked in a 4.25% rate on a new $240,000 mortgage loan. He used about $45,000 of it to buy a Mercedes for his wife. Though his new loan was bigger, his monthly payment hardly changed, thanks to the lower interest rate. "It's like free money," he said.
In Glastonbury, across the Connecticut River, medical-device sales manager Paul Popovich missed this window. He applied to refinance the mortgage on his home in mid-October, hoping to lop $150 off his $2,200 monthly payment. But rates started rising again before he could complete the process. "We were hoping for some relief, and it hasn't occurred yet," he said. Rates on 30-year mortgages now average 4.61%, their highest in six months, according to Freddie Mac.
Lowering rates can't put money in the pockets of many others because banks won't lend to them. About 11 million homeowners owe more on their mortgages than their homes are worth, making refinancing practically impossible.
Steve Ross, an apparel entrepreneur in Eastern Shores, Fla., has a $200,000 mortgage with an interest rate of 6.75%. He estimates the seaside condo he bought for $300,000 in 2006 is now worth $150,000—too little to serve as collateral for a new loan that could reduce his $2,000 a month in mortgage costs and condo fees. The Fed's stimulus "is not doing me any good," Mr. Ross said. "The bank isn't going to call me up and lower my interest rate."
About 70% of U.S. mortgage holders were paying at least one percentage point more than the going interest rate for 30-year fixed-rate mortgages in October, according to a Wall Street Journal analysis of data from research firm LPS Applied Analytics.
As for inflation, the economic cross winds are pulling it in different directions. Strong demand from overseas is pushing up the prices for many globally traded goods, including a white pigment used in paint called titanium dioxide. Huntsman raised titanium dioxide prices 17% earlier this year, and paint maker Sherwin-Williams Co. has raised paint prices.
When the Fed buys bonds from banks, it is in effect creating money, because it simply credits with cash the banks from which it buys the bonds. Flooding the financial system with more money could cause inflation.
The Fed doesn't see that as a risk because other forces are pushing inflation down, including banks' reluctance to lend and the overhang of unemployed workers, empty homes and unused plant capacity. Also, many domestic services aren't exposed to the buoyant global demand that is pushing Huntsman's titanium dioxide higher.
Danny Sayag, who runs two hair salons in Rockville, Md., is keeping the price of women's haircuts between $65 and $75. Rent at one of his two salons was reduced because of the soft real-estate market, and labor costs aren't rising because some other salons have closed and left stylists job hunting.
"It is not the right time to raise prices," Mr. Sayag said. "Why push the clients away from us at this kind of time?" Across the economy, the cost of a haircut in October was 0.4% higher than a year earlier, after averaging increases of over 3% for a decade, according to the Bureau of Labor Statistics.
Meanwhile, much of the money the Fed has created is sitting unutilized at banks, in saving accounts or in corporate coffers, reducing its potency as a source of either growth or inflation. U.S. nonfinancial businesses increased their liquid assets $1.932 trillion in the third quarter, a jump of $243 billion from a year earlier, according to the Fed. Banks' commercial and industrial loans outstanding in November were down 7.2% from a year ago; their holdings of low-risk Treasurys were up nearly 17%.
Mr. Sayag in Maryland says he has long been trying to get a loan from local Sandy Spring Bank to develop a plot of land to open a third hair salon, a beauty school and a supply store. He has been turned down, he says, because of the weak economy. "I don't blame the bank. It was the timing," he said. Since September 2008, SandySpring's portfolio of loans and leases has contracted to $2.1 billion from $2.4 billion, according to filings with the Federal Deposit Insurance Corp.
The bank's CEO, Daniel Schrider, declined to discuss individual clients, but said the bank's main goal in the past few years has been to clean up troubled construction and land-development loans. Though that process isn't over, he said, the outlook for lending is starting to look up. "We have transitioned...toward being much more interested in growing our business through quality credit opportunities," he said.
Mr. Sayag has restarted the process for a $2.5 million loan, and thinks he will get it this time because business is better and the cost of building is down. But, he added, "It's not going to happen overnight."
Write to Jon Hilsenrath at and Mark Whitehouse at