Friday, September 25, 2009

Fed to slowly exit housing market

WASHINGTON: The Federal Reserve, acknowledging that an economic recovery has begun, took a cautious step on Wednesday towards weaning the US housing market off its trillion-dollar support programme.

But even as policymakers expressed new optimism about growth, they also conveyed the difficulties that lie ahead in removing the vast safety net they have erected over the last year.

'Economic activity has picked up following its severe downturn,' the central bank said in a statement after a two-day policy meeting. It said financial markets had improved further, that activity in the housing market had increased and that household spending seemed to be stabilising.

But Fed officials also cautioned that the recovery would be slow and repeated their vow to keep the benchmark overnight interest rate at virtually zero for 'an extended period'. That almost certainly means until at least sometime next year.

Most notably, policymakers also announced that they would slow down the Fed's programme to buy almost US$1.5 trillion (S$2.1 trillion) worth of mortgage-related securities and stretch it out through the end of March.

That programme is aimed at keeping mortgage rates low and propping up the housing market. But the Fed now dominates the mortgage market so much that many analysts predict it will be difficult for the central bank to extract itself.

'I don't think there are enough private buyers to replace the central bank,' said Professor Sung Won Sohn, professor of economics at California State University. 'If there is even an inkling that the Fed is going to start selling by 2010, we would see mortgage rates go up right away.'

US stocks fell 0.8 per cent after the announcement on Wednesday as investors worried the Fed is closer to pulling back on extraordinary measures to inject funding to shore up the economy.

Fed officials did not even hint at a timetable for selling the central bank's huge mortgage portfolio. But to prevent disruptions when it simply stops buying, the Fed said it would gradually phase out its purchases over the next six months.

Even that could cause heartburn for prospective home buyers. Analysts estimate that the Fed is buying more than 80 per cent of new mortgage-backed securities.

Private investors have retreated to the sidelines, and no one is sure how rapidly they will return if the Fed retreats.

Mr Ian Shepherdson, a forecaster at High Frequency Economics, said private credit markets were still so weak that an important measure of the money supply, known as M-2, had actually edged down in recent months. That is the opposite of what is supposed to happen under the Fed's policy of 'quantitative easing', under which it creates large volumes of money out of thin air to buy Treasury bonds and mortgage-backed securities.

'That tells you that the volume of private credit is falling,' Mr Shepherdson said. If the Fed stops its purchases, he added, the money supply might fall sharply and make credit even harder to obtain. 'I just wonder whether they have the stomach for that kind of contraction,' he said.

In a sign that officials were worried about how jittery markets might become, the Federal Reserve Bank of New York issued an unusual follow-up statement on Wednesday to explain how it planned to scale back the purchase of mortgage securities.

It said the process would start this week, with its purchases of mortgage-backed securities gradually declining in volume. It also said it would gradually reduce both the frequency and the volume of its purchases of debt issued by Fannie Mae, Freddie Mac and other federal agencies that guarantee mortgages.

The Fed has already phased out some of the emergency lending programmes it created during the financial crisis last fall. It is also wrapping up its programme to buy US$300 billion worth of Treasury bonds, stretching out its final purchases through the end of next month.

The Fed's chairman Ben Bernanke has warned that ending the stimulus programmes too quickly could tip the US back into a recession - the same mistake policymakers made in the 1930s.

Fed officials say they are under no pressure to raise interest rates quickly. With unemployment approaching 10 per cent, and underemployment pushing the true jobless rate above 16 per cent, Fed officials expect wage pressures to remain scant.


Source: Straits Times, 25 Sep 2009

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