Federal Reserve officials moved to prevent the central bank's huge balance sheet from shrinking, in an attempt to spur the U.S. economy's recovery and avoid deflation.
At the end of a policy meeting Tuesday, Fed officials said they would reinvest the proceeds from maturing mortgage-backed securities in U.S. Treasuries, focusing on the two- to 10-year range. The move is aimed at kick-starting the economy by helping to keep borrowing costs low. The latest move by the Fed represents a tweak in its strategy for managing its huge portfolio. But it's a significant one, since it could be a step toward new large purchases of both government bonds and MBS.
Currently, the proceeds of expiring mortgage bonds are not being reinvested, meaning the Fed's balance sheet would have slowly shrunk over time. Buying Treasuries with the cash from MBS — projected at about $200 billion by 2011 — should help keep borrowing costs low. When a company issues a bond, for example, the interest it pays is often tied to what government bonds are yielding.
The Fed said it would concentrate its buying in securities in the two- to 10-year range, though it is open to buying other maturities, as well as inflation-indexed bonds. The central bank refrained from restarting large-scale asset buying, likely to keep that option in case the economy weakens further.
In response to the economic crisis, the Fed has already bought $1.7 trillion in mortgage and Treasury debt in 2009 and earlier this year. The program is estimated to have cut long-term rates by half a percentage point. Some officials have reservations about restarting full-blown asset purchases because they are not sure they can drive down long-term rates further from already-low levels. Average rates for a 30-year mortgage fell last week to 4.49%, according to Freddie Mac, the lowest rate since the 1950s. Holding many more securities could also cause problems further down the road.