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Fed downgrades recovery outlook

The US Federal Reserve on Tuesday took a first step toward extending its crisis-era monetary policy regime, as it downgraded its view of the economic outlook amid rising fears of a “double-dip” recession.

Meeting in Washington, Fed monetary policymakers agreed to begin reinvesting more than $150bn (£95bn) in annual proceeds from maturing mortgage-backed and agency securities into Treasury debt, halting plans to allow a natural shrinkage of the $2,300bn balance sheet the US central bank built up during the recession.

The move signals a significant shift in thinking at the Fed, which only a few months ago was tilting towards tightening monetary policy to fend off inflation as the economic recovery gathered strength. Fed officials significantly downgraded their economic outlook, saying the “pace of recovery in output and employment has slowed in recent months” and was likely to be “more modest” than anticipated in the near term.

When the Federal Open Market Committee last met in June, it said the economic recovery was “proceeding” and was likely to advance at a “moderate” pace. The reinvestment of proceeds from the expiring securities does not in itself represent an easing of monetary policy, since it simply allows the size of the Fed’s balance sheet to remain steady.

The decision could be reversed relatively easily by the Fed if the economy improves over the next few months. But it does signal that the bias of monetary policy has decisively shifted away from tightening towards easing – a potential precursor to large-scale asset purchases like those carried out during the financial crisis if conditions deteriorate further.

Indeed, the Fed left room to be more aggressive, saying, as it did in June, it would “continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to promote economic recovery and price stability”.

Interest rates were kept at their target range of 0-0.25 per cent, and the Fed maintained its pledge to hold them there for an “extended period”.

Stocks pared some of their losses, Treasury yields fell further while the dollar trimmed gains after investors digested the FOMC’s statement.

The S&P 500 was down 0.6 per cent, after falling as much as 1.4 per cent in early trade. Equity markets had closed lower in Asia, Europe and London ahead of the Fed meeting. The yield on 10-year Treasury notes dropped to 2.77 per cent from 2.82 per cent. The dollar index was up 0.3 per cent on a trade weighted basis to its main rivals at the close of New York trading. Earlier on Tuesday, the US Treasury sold $34bn three-year notes at a record low yield of 0.844 per cent amid strong demand.