Fed’s Treasury purchases to devalue dollar

The U.S. Federal Reserve has announced it will buy up to $300 billion in longer-term treasury bonds, in the central bank’s latest effort to shore up the American economy.

“To provide greater support to mortgage lending and housing markets, the committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities,” the Federal Open Market Committee said in a statement in Washington today. “Moreover, to help improve conditions in private credit markets, the committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months.”

The Fed also reaffirmed its near-zero interest rate policy, holding its trend-setting Fed funds rate between 0% and 0.25%. The Fed will also increase its purchases of mortgage and agency debt.

“What the Fed is doing right now is they are truly printing money, they are monetizing the debt,” says Christine Hughes, a senior vice-president and lead portfolio manager of the AGF Canadian Balanced Fund.

“The Fed has had trouble effectively reducing long mortgage rates. What they’ve been trying to do is narrow the spread between the free- floating interest rate of treasuries and the mortgage rate they are trying to compress the spread by buying those mortgages,” she explains. “They’ve had trouble doing that, so what they are going to do is try to push down the actual rate mortgages are tied to, which is the treasury bond. This is printing money the way like no other way to print money; the way money was printed in the Depression and in Japan over the last decade.”

Hughes says the Fed hopes the move will devalue the U.S. currency, which in turn will decrease its trade deficit by making cheap imports more expensive.

“This is a way to manage down your currency because it’s been too strong. [The strong dollar] is killing your exports,” she says. “The U.S. economy has been unduly hurt by the rally in the U.S. dollar over the last few months.”

In the near term though, she expects the buying spree to rally the bond market.

“This, in my mind, is very major — this is what I’ve been waiting for in the treasury market,” she says. “The Fed is trying to push this rate down which is why a bull market in bonds will continue and why I have a very hefty [Government of Canada] bond weight.”

(03/18/09)

Staff

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