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Federal Reserve Slows Treasury Purchases as the Economy Starts to Recover

By , Money Morning •

The U.S. Federal Reserve yesterday (Wednesday) indicated that economic activity is "leveling out" and the central bank's program to buy Treasury securities will be shut down by the end of October.

"Information received since the Federal Open Market Committee (FOMC) met in June suggests that economic activity is leveling out," the central bank said in a statement following its two-day meeting Aug. 11 and Aug. 12. "Conditions in financial markets have improved further in recent weeks. Household spending has continued to show signs of stabilizing but remains constrained by ongoing job losses, sluggish income growth, lower housing wealth, and tight credit."

Data released last week showed the U.S. economy contracted at an annual rate of 1% in the second quarter, better than analysts had anticipated. The national unemployment rate also contracted in July, falling to 9.4% from 9.5% in June. Fueled by President Barack Obama's $787 billion stimulus plan, the U.S. economy could expand by more than 2% in the second half of 2009, according to analysts' estimates.

With the economy showing signs of improvement, Federal Reserve Chairman Ben S. Bernanke - who has been under pressure to wind down stimulus programs before inflation gets too deeply rooted in the economy - said he would slow the pace of the central bank's $300 billion program to buy U.S. Treasuries.

The Fed has bought $252.8 billion of longer-term securities since the plan was announced on March 18. The full amount of Treasuries will be purchased by the end of October.

Additionally, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year.

"What he needs to do is to begin to wind this down" to prevent an acceleration in inflation, Allan Meltzer, a Fed historian and economist at Carnegie Mellon University in Pittsburgh, told Bloomberg. "It takes about two years from the time we start reducing money growth to the time we get some benefits" in containing prices.

However, Bernanke also said that while economic conditions have improved, the benchmark Federal Funds rate would remain "exceptionally low" for "an extended period" of time. The rate currently stands at a record-low range of 0-0.25%.

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