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“Very Unusual” Fed Action Fails To Boost Animal Spirits: Dow Drops 285

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The Fed's latest moves to bring down long-term interest rates will be "marginally helpful," predicts former Fed Governor Mark Olson, now co-chair of Treliant Risk Advisors, a compliance and strategic advisory firm specializing in the financial services industry. "There really isn't a lot of room" left for the Fed to bring down rates.

Specifically, the Fed announced plans to buy $400 billion of long-term Treasuries and sell an equivalent amount by the end of June 2012. The so-called Operation Twist will not change the size of the Fed's balance sheet but the duration of its Treasury holdings. "This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative," the FOMC statement declares.

In addition, the Fed announced plans to reinvest principal payments from its current holdings of agency debt and agency mortgage-backed securities into agency MBS. In other words, the Fed is going to be buying paper from Fannie Mae and Freddie Mac again "to help support conditions in mortgage markets."

Treasury prices did rally in response to the Fed announcement with the yield on the benchmark 10-year note falling to a record low 1.86%, while the yield on the 30-year bond slipped to 3.01%.

If the Fed was trying to lower long-term rates, the action was a success. If the goals was to boost the stock market, the action was a total failure, although perhaps traders focused on Moody's downgrade of Bank of America, Wells Fargo and Citigroup vs. the Fed, which did say "there are significant downside risks to the economic outlook, including strains in global financial markets."

Tumbling into the close, the Dow shed 285 points, or 2.5%, while the S&P lost nearly 3% and other so-called risk assets like gold and oil fell sharply as the dollar rose.

Very Unusual

While Operation Twist was widely expected, the MBS announcement was a bit of a surprise, as was the timing of the Fed's announcement, some 10 minutes after its normal 2:15 ET release.

The Fed's failure to meet its (self-imposed) deadline is "very unusual," Olson says, suggesting there was likely some last-minute wrangling over the wording of the release.

Although three Fed governors dissented from Wednesday's policy action — Dallas Fed President Richard Fisher, Minneapolis Fed President Narayana Kocherlakota, and Philadelphia Fed President Charles Plosser — Olson notes they were the same dissenters at the August meeting "so I don't think that in particular was much of a surprise."

For the record, Olson says he would have voted for Wednesday's action if he were still a voting member of the FOMC.

"I would have because I don't see any downside risk to it," he says. "Should inflationary pressures start to build, it's a circumstance where they can adjust that portfolio just a quickly and reduce the size in a way that won't have long-term negative implications."

But positive implications? That remains very much in doubt.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him at altask@yahoo.com

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