Financial markets tumbled after the Fed announced to extend the average maturity of its holdings of securities so as to stimulate the economic recovery and to help ensure inflation is consistent with the dual mandate over time. While the measure had been widely anticipated, investors doubted its effectiveness in bolstering the economic recovery and stimulating the job market. They hoped the Fed would do something stronger, i.e. outright bond buying. Wall Street slumped with DJIA and S&P 500 losing -2.49% and -2.94% respectively. In the commodity sector, major oil benchmarks slipped. Losses widened markedly in Asian session today. Gold rose a tad yesterday on safe-haven demand. However, gains were erased as the metal plummeted in tandem with others in the commodity market.
The Fed announced something called 'operation twist' yesterday. The Committee will buy $400B of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. 32% will be allocated to the 6-8 year sector, another 32% to the 8-10 year sector, 4% to the 10-20 year sector, 29% to the 20-30 year sector and 3% to TIPS (6-30 years). The purchases will be completed by the end of June 2012. The Fed believed that the program should 'put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative'. Additionally, the Committee will also reinvest principal payments from agency debt and agency MBS back into agency MBS in order to support conditions in mortgage markets. This measure was probably not expected by the market.
It's hard to say what the Fed will do next if economy conditions deteriorate further and market sentiment continued to weaken. Measures left unused are reduction IOER and additional quantitative easing. The former is indeed less effective that operation twist in our opinion while more rigorous debate will be generated among the members with regard to the latter as three dissenters have opposed the measures announced yesterday.
The situation in the Eurozone remained worrisome. The ECB reported one bank tap $500M in the 7-day dollar tender, after 2 banks borrowing $575M last week. We believe this indicates the drying up of the region's banking system. With the FOMC meeting over, the market focus will probably be shifted back to the sovereign debt problems in the 17 nation region.