Fed prepares for last spurt of easy money flood

Date: 6/10/2011

By Richard Leong Richard Leong – Fri Jun 10, 4:11 pm ET

NEW YORK (Reuters) – The flood of Federal Reserve money that has supported Wall Street and the rest of the U.S. economy for 2–1/2 years will shrink to a trickle with the conclusion of the Fed's bond purchases announced on Friday.

The Fed said it will buy $50 billion of Treasuries, the final series of government bond purchases that marks the last phase of the $600 billion program it launched in November 2010 to prevent another recession.

As a result, once the purchases are concluded on June 30, the financial sector will receive only a fraction of the roughly $100 billion a month in easy money it has been getting from the Fed.

The conclusion of the Fed's bond–buying program, known as "Quantitative Easing 2," does not mean the stimulus will come to a complete stop. The Fed will reinvest maturing securities, mainly mortgage–related debt, which analysts predict will run at $12 billion to $16 billion per month.

"From a psychological standpoint, it is important for the market to still feel the constant presence of the Fed," said Ralph Axel, interest rate strategist at Bank of America Merrill Lynch in New York.

This gradual approach to unwind policy support is likely needed given investor anxiety over a slowing U.S. economy and the festering public fiscal problem in Europe.

While still a lot of money, it is a huge step down from stimulus levels at the height of the buying campaign, dubbed by markets as QE2 because it was the second round of Fed asset–buying in the wake of the 2008 financial crisis.

A key aim of QE2 was to hold down long–term interest rates to stimulate investment in capital equipment and risky assets. It came almost eight months after the Fed's first round of bond purchases, primarily in mortgage–related securities.

The initial bout of quantitative easing, worth $1.73 trillion, began in December 2008 and ended in March 2010. It was created to stabilize the housing sector, which was the epicenter of the financial turmoil and has yet to show signs of recovery.

The Treasury bond component of the first round of purchases totaled $300 billion, from March to October 2009.

The Fed's buying assets has been controversial from the start. Critics say it is tantamount to printing money, and it has been credited with fueling a stock market rally but blamed for a surge in oil and food prices.

The end of QE2 has been well–flagged. The Fed said at the outset it would run until the end of June 2011.

Still, investors expect stocks, bonds, gold and the euro to fall after it ends, according to a Reuters poll of 64 analysts and fund managers last month.


Come July, the Fed will rely on cash generated from its $1 trillion holding of mortgage–related securities to anchor Treasury yields and support the economy.

Proceeds from Fed's maturing mortgage–backed securities and debt issued by Fannie Mae, Freddie Mac and the Government National Mortgage Association (Ginnie Mae) will fluctuate monthly depending on house sales and mortgage refinancings.

Recent evidence suggested the real estate conditions are deteriorating again with single–home home prices dropping below their 2009 low in March. The double–dip in housing will likely be compounded by an abrupt slowdown in job growth in May.

This grim development portends that a housing recovery is farther than previously thought and would take longer for people to sell their homes and to pay off their mortgages. This means mortgage securities will not be prepaid quickly.

"We are still at least two to three years away from seeing signs of even a baby upturn in home prices," said Anthony Karydakis, senior economist at Commerzbank in New York.

Going back to the 1950s, housing starts have typically returned to their pre–recession levels in 1–1/2 to 2 years after they hit bottom. But the current housing market is showing "atypical" behavior since its euphoric highs earlier this decade, Karydakis said.

Housing starts are stagnant after 1–1/2 years into the current economic recovery and more than a year since the initial bout of bond purchases. They had enjoyed a brief revival due to a federal first–time homebuyer credit program.

"Housing starts have stabilized at very low levels, but there have been no signs of a recovery," Karydakis said.

In April, housing starts fell 10.6 percent to an annualized rate of 523,000 units.

(Additional reporting by Burton Frierson and Chris Reese; Editing by Diane Craft)


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