Fed Unveils New Round of Bond Buying

In a bid to invigorate the economy in the face of the looming fiscal cliff, the Federal Reserve on Wednesday announced plans to extend an expiring Treasury-buying program and for the first time adopted specific monetary policy thresholds to help communicate with investors.

At the conclusion of a two-day meeting in Washington, the Federal Open Market Committee voted 11-1 to keep interest rates at record lows and continue a version of the expiring “Operation Twist” program. The Fed said it will initially buy about $45 billion of Treasurys a month when the program concludes at the end of the year.

However, unlike the prior instance of Treasury buying, the Fed will no longer sterilize the asset purchases by selling short-term bonds, meaning its balance sheet will continue to swell each month from its current level of $2.84 trillion.

The central bank also said it will continue buying mortgage-backed securities at a clip of $40 billion per month as part of its controversial QE3 program, which was first unveiled in September.

In a landmark shift, the Fed surprised the markets by voting to tie its monetary policy to specific economic targets in an effort to better signal its previously-mysterious plans with the marketplace.

As part of these new policy thresholds, the Fed said it will keep interest rates at their historically-low levels as long as unemployment stays above 6.5% and inflation is seen below 2.5%. Previously, the Fed said it expected to keep rates exceptionally low until the middle of 2015.

“We interpret today's action as a continuation of the bold shift in Fed policy that began in September,” analysts at Barclays (NYSE:BCS) wrote in a note to clients. “These moves indicate that the accommodation switch has been ‘turned on’ and the data have to tell the committee when to stop.”

'Downside Risks' Remain

The Fed, which strongly hinted at its September meeting that it would extend the Treasury-buying program, hopes these asset purchases will keep borrowing rates affordable and encourage companies to invest by hiring new workers.

As the Fed increases its intervention into the economy, the central bank slightly downgraded its growth prospects for 2012 and 2013, projecting U.S. gross domestic product to increase no more than 1.8% this year.

Policy makers “remains concerned that, without sufficient policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions,” the FOMC statement read. “Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.”

Underscoring the concern, the Fed did not tie its bond-buying -- now at a combined $85 billion a month -- with the new economic thresholds unveiled.

Jeffrey Saut, chief investment strategist at Raymond James &  Associates, told FOX Business he believes the latest moves show that Ben Bernanke is likely our most creative Fed head of our time."

Too Much Fed Intervention?

However, a growing number of economists -- 52% in the latest poll by The Wall Street Journal -- believe the risks of the Fed doing more outweigh the economic benefits. Some are concerned the central bank’s aggressive campaign is starting to disrupt market dynamics and could spark a dangerous asset bubble.

“The book is far from finished on the Greenspan/Bernanke Fed. In the meantime, markets will continue the dance of slow economic/earnings growth on one hand and massive central bank money printing on the other,” Peter Boockvar, a managing director at Miller Tabak, wrote in a note to clients.

After initially fluctuating on the news, equity markets responded positively to the major FOMC decision, with the Dow Jones Industrial Average trading up nearly 70 points in mid-afternoon action.

The backdrop for the latest Fed intervention is a U.S. economy that has grown at a lackluster annual rate of just under 2% since the end of 2010 and an unemployment rate that has dropped yet remains painfully high at 7.7%.

The Fed noted that the unemployment rate remains “elevated” and said overall economic activity has continued to expand at a “moderate pace.”

At the same time, Washington has less than three weeks remaining to reach a compromise to avoid sending the U.S. over the fiscal cliff, the $600 billion batch of spending cuts and tax increases set to take effect at the start of next year.

The lone dissenter in Wednesday’s Fed moves was Richmond Fed President Jeffrey Lacker, who opposed both the bond buying and new thresholds.

Fed Trims Growth Prospects

Meanwhile, the Fed dimmed its economic outlook, projecting U.S. GDP growth of between 1.7% and 1.8% in 2012, down from its September forecast for growth of 1.7% to 2%.

On the other hand, the central bank cut its 2012 unemployment rate view to a range of 7.8% to 7.9%, an improvement from 8% to 8.2% previously.

Looking further out, the Fed now sees GDP growth of 2.3% to 3.0% for 2013, compared with 2.5% to 3% previously. Unemployment rate is seen ranging between 7.4% and 7.7% next year, compared with 7.6% to 7.9% earlier.

The Fed also continues to see inflation staying under control, projecting PCE inflation to stay at 2% or lower through 2015.

Later on Wednesday, Fed chief Ben Bernanke is scheduled to issue a statement before taking questions from reporters likely to be focused on the state of the economy and the ongoing fiscal cliff negotiations.