Fed Moves to Support Low Mortgage Rates

The Open Market Committee said it would resume buying long-term Treasury bonds.

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Facing growing concerns that it's out of ammunition, the Federal Reserve pledged Tuesday to battle the slowing economy by purchasing more long-term U.S. Treasury securities.

Acknowledging that "the pace of economic recovery is likely to be more modest in the near term than had been anticipated," the Fed's Open Market Committee said it would reinvest payments from Fannie Mae and Freddie Mac debt and mortgage-backed securities into longer-term government bonds. The Fed completed its purchase of $300 billion of government debt several months ago. (The goal of the program is to keep the Fed's portfolio of U.S. Treasury debt at current levels.)

The move comes as economists express growing concern about the possibility of a double-dip recession. The Commerce department reported late last month that gross domestic product increased 2.4 percent in the second quarter, down from 3.7 percent during the previous three months. At the same time, the Fed is unable to bring its main policy lever—the federal funds rate—any lower. The federal funds rate currently stands in a rock-bottom range of zero to 0.25 percent.

David Resler, chief economist at Nomura Securities, said the Fed's move was partly symbolic. "It is a reminder to those Doubting Thomases that the Fed does still have arrows in its quiver and it is willing to fire them whenever they need to."

At the same time, the move could have a tangible effect. Government purchases of such Treasury debt can put downward pressure on long-term interest rates, which helps to stoke economic activity.

But how much impact will the newly announced purchases have? Not a great deal, says Michael Gapen of Barclays. "Our view is that simply reinvesting the proceeds from maturing agency securities will not provide much additional stimulus," Gapen says in a report. "Should the outlook continue to worsen, then the Fed will likely initiate a new round of asset purchases, most likely in Treasury securities."

Indeed, long-term interest rates are already extremely low. Thirty-year fixed mortgage rates, for example, fell to 4.49 percent for the week ending August 5. That's the lowest level since the 1950s.

However, the new program not only signals to the market that the Fed is willing to step in to support economic growth, but it also gives the Fed the flexibility put a lid on interest rates should they begin rising, says Keith Gumbinger of HSH.com. "At some point, investors are going to look for more risky assets—they are going to go buy stocks, they are going to go buy overseas stuff—and yields would likely rise as a result," Gumbinger says. "This allows the Fed an opportunity. If the market shifts they still have a mechanism they can employ quickly to keep interest rates low."

In addition, the Fed affirmed its previous commitment to keep the federal funds rate at near zero for "an extended period."