Fed Effort to Aid Recovery Fails to Calm Investors (zt)

Fed Effort to Aid Recovery Fails to Calm Investors

By Scott Lanman and Joshua Zumbrun - Aug 12, 2010

The Federal Reserve’s first attemptto bolster the flagging U.S. recovery shows no sign ofdispelling investor concerns the world’s largest economy mayslide back into a recession.

The Standard & Poor’s 500 Index fell for a third straightday today after paring losses in the hours after the centralbank’s Aug. 10 announcement it would sustain its assets at thecurrent level. A subsequent decline in 10-year Treasury yieldshasn’t yet filtered through to corporations now paying higherpremiums.

The central bank said it will buy Treasuries with proceedsfrom mortgage holdings and set a $2.05 trillion floor on itsholdings of government bonds and housing debt to buoy aneconomic recovery it said is slower than forecast. The Fed’sfailure to spell out its objectives may have fanned investoranxiety the expansion wouldn’t last, said Charles Lieberman, aformer New York Fed official.

“The Fed is effectively saying that they need to find waysto resuscitate the economy, and the mere fact that they’reacknowledging that reinforces the fear that’s out there,” saidMatthew Kaufler, a money manager at Federated Clover InvestmentAdvisors in Rochester, New York, which manages $3 billion.

The central bank’s statement followed a government reportlast month showing the recession that started in December 2007,already deemed the deepest since the 1930s, was worse thanestimated.

A July 30 revision by the Commerce Department showedhousehold spending fell 1.2 percent in 2009, twice as much aspreviously projected and the biggest decline since 1942. Also,companies reported hiring a less-than-forecast 71,000 employeeslast month.

‘Created Worries’

“They’ve actually created worries in the market thatthings are going to be worse than people previously thought,”Frederic Mishkin, a Columbia University economist and former Fedgovernor, said today in an interview on Bloomberg Television’s“InBusiness with Margaret Brennan.”

The Fed said this week that “the pace of economic recoveryis likely to be more modest in the near term than had beenanticipated.” Policy makers repeated their pledge to keepinterest rates “exceptionally low” for an “extended period.”The Fed’s benchmark rate has been at a range of zero to 0.25percent since December 2008.

Equity Markets

“Investors’ interpretation is, ‘What does the Fed knowthat we don’t?’” about concerns such as foreclosures andfinancial regulation, said John Lynch, chief equity strategistat the Wells Fargo Funds Management division of San Francisco-based Wells Fargo & Co. that oversees $465 billion. The declinein equity markets reflects “investors extrapolating from thestatement.”

Stock markets around the world fell this week. The MSCIWorld Index of stocks in 24 developed nations dropped 2.84percent yesterday and 0.63 percent today as of 4:10 p.m. in NewYork.

The Nikkei 225 Stock Average fell 0.86 percent today and2.7 percent yesterday. The Standard & Poor’s 500 fell 0.5percent to 1,083.61. The index, while down 2.8 percent for 2010,is up 7.2 percent from its low for the year on July 1.

“The market didn’t see the Fed’s statement as providingsignificant support for the economy,” said Lieberman, chiefinvestment officer at Advisors Capital Management LLC inHasbrouck Heights, New Jersey. “It saw what the Fed was doingas relatively minor in size and importance.”

Yields on 10-year Treasury securities rose to 2.75 percenttoday from 2.68 percent yesterday after starting the week at2.82 percent and the year at 3.84 percent.

Bond Price

The average investment-grade bond price has jumped about5.5 cents to 110.65 cents on the dollar this year, while theaverage high-yield price has gained more than 3 cents to 98.76cents on the dollar, according to Bank of America Merrill Lynchindex data.

The Fed could have been clearer in the statement about howits action would help the economy and sent a stronger signalthat it was prepared to take further steps should the economyweaken, Lieberman said, adding investors are probably being toopessimistic about the economy and corporate profits.

The Fed plans to limit its support in the first month topurchases of $18 billion in Treasuries.

Corporations’ borrowing costs haven’t fallen as fast asTreasury yields, with the difference between companies’ ratesand comparable government securities widening to 1.90 percentagepoint yesterday from 1.86 point on Aug. 9, according to Bank ofAmerica Merrill Lynch index data. For high-yield bonds, thepremium widened to 6.78 percentage points from 6.54 points, thebiggest gap since July 20.

Bond Sale

International Business Machines Corp., the world’s biggestcomputer-services provider, sold bonds with coupons at historiclows last week. The yield on those bonds rose 1 basis point to1.03 percent yesterday. A basis point is 0.01 percentage point.

While the Fed’s action may reduce mortgage costs, it won’tnecessarily help the housing market. “It pushes rates lower,but it doesn’t change the reality for many would-be borrowers”who are worried about their jobs or lack money for a downpayment, said Greg McBride, a senior financial analyst atBankrate Inc. in North Palm Beach, Florida.

Mortgage rates for U.S. home loans set a record low for theeighth straight week, Freddie Mac, the home-finance provider,said today. The average rate of a 30-year fixed-rate mortgagedropped to 4.44 percent in the week ended today from 4.49percent.

“The Fed is basically adding more money, but what’s neededright now is not more money,” said David Darst, the New York-based chief investment strategist at Morgan Stanley SmithBarney, which oversees $1.6 trillion. “What’s needed is moreconfidence, more animal spirits.”