FED FOCUS-Fed expands playbook to boost ailing economy
By Ros Krasny
CHICAGO, Oct 29 (Reuters) - The severity of the shock facing the U.S. economy has not been lost on Federal Reserve policy-makers, who seem committed to pulling out all stops to brighten a distressingly bleak outlook.
The downbeat note struck in Wednesday's Federal Open Market Committee statement was a dramatic departure from just six weeks ago, when the Fed judged that growth and inflation risks were roughly equal.
Facing the worst potential economic downturn in decades, the Fed lowered its benchmark interest rates by half a percentage point and seems likely to lower benchmark lending rates yet again in December.
As its rate-cutting ammunition shrinks though, the Fed will be forced into a "quantitative easing" regime that many analysts say they have already quietly launched.
"They are effectively in quantitative easing," said Steve Ricchiuto, chief economist at Mizuho Securities in New York, referring to the monetary policy strategy adopted by the Bank of Japan in the early 1990s to fight deflation when short-term interest rates had already been pushed close to zero.
Although no official program has been announced by the Fed, the process looks well under way. The U.S. central bank has been flooding markets with liquidity and appears content to see the effective federal funds rate in the interbank market trade far below the announced target rate.
"Based on the ... effective rate, it is clear that the Fed is not fully sterilizing its open market operations," said economists at Deutsche Bank. "This is a positive development, because it means the abundance of dollars should further lower Libor." The Libor interbank rate often used as a benchmark for consumer loans.
Federal funds traded at 0.25 percent ahead of the Fed's rate cut announcement on Wednesday and even lower, to 0.125 percent, afterward.
Over the past ten days it has averaged about 0.74 percent, well below the 1.5 percent target that prevailed before the central bank lowered it yet again to 1.0 percent on Wednesday.
"History will likely view the true story of this easing cycle being as much about the Fed's version of a Bank of Japan-style quantitative ease, as it is about the myriad of acronym-laced targeted lending facilities," said Max Bublitz, chief strategist at SCM Advisors LLC in San Francisco.
WARP SPEED
Compared with the BOJ's program in the early 2000s, the Fed has moved with warp speed to expand its balance sheet as a result of those myriad measures to unlock credit markets.
Twin catalysts have been a program the U.S. Treasury announced on Sept. 17 to borrow on behalf of the Fed and the Fed's recently won ability to pay interest on bank reserves -- part of a financial rescue bill signed into law earlier this month.
"Whereas the BOJ increased its balance sheet by about 35 percent over three years, the Fed has doubled the size of its balance sheet in about a month," said Barclays Capital economists Paul Sheard and Zach Pandl.
"The BOJ pioneered 'unconventional' policy; the Fed is showing how it is really done."
Wednesday's interest rate cut was the second within a month in response to what has been pegged as the worst financial crisis since the Great Depression.
Futures markets that handicap potential interest rate moves point to another quarter-point cut, to 0.75 percent, at the Fed's next meeting in December, and some Fed watchers see the end-point of the current cycle at 0.5 percent.
"I think they are going to stop here, but I have to admit that it is possible that they could go lower, and many people are suggesting that they will," said Kevin Logan, senior economist at Dresdner Kleinwort in New York. (Additional reporting by Pedro Nicolaci da Costa and Richard Leong in New York)
