The US Federal Reserve on Tuesday took the unprecedented step of promising to keep interest rates near zero for at least two more years and said it would consider further steps to help growth, sparking a rebound in stocks.
The Fed painted a gloomy picture, saying that as US economic growth was proving considerably weaker than expected, inflation should remain contained for the foreseeable future and unemployment, currently at 9.1 percent, would come down only gradually.
An unusually divided central bank pledged to hold benchmark rates at rock-bottom lows until mid-2013 and opened the door to other tools to support growth. The announcement demonstrated just how long the central bank expects it will take before a flagging economy can gather significant momentum.
Financial markets, hungry for support from the Fed after bruising losses the past eight days that wiped US$3.8 trillion from global stock portfolios, were jolted by the news.
US stocks sank initially and then see-sawed wildly before a strong rally. The Dow Jones ended up 4 percent, or 429.92 points, at 11,239.77. US Treasury yields sank with the two-year note plunging to a record low of 0.1647 percent and the US dollar sinking.
However, there was doubt over how long the rally might last given the weak outlook. In a Reuters poll of primary dealers who trade directly with the Fed, an increased number said they expected the central bank would have to fire off another gun before long — buying bonds to lower rates even further, known as quantitative easing (QE).
The poll found that 37.5 percent now see the Fed resuming bond-buying within the next six months, compared with 27.5 percent who had expected more QE within two years when they were polled on Friday last week.
“If they have to act, they will,” said Alberto Bernal, head of emerging markets fixed-income research at Bulltick Capital Markets. “They didn’t act today because they didn’t want to send a specific message of panic.”
The Fed said that three policymakers dissented, the biggest such rebellion since 1992, pointing to unusual uncertainty about the outlook and reticence within the Fed about the effectiveness of unconventional policy.
Markets will now be looking to US Fed Chairman Ben Bernanke’s yearly speech at the upcoming Jackson Hole meeting for further clues into any additional policy easing the Fed might consider at its next policy meeting next month.
There is plenty of doubt about the Fed’s power to stimulate the economy with rates already so low. Japan provides a disheartening example of a country that has kept borrowing costs low for many years without any notable spike in growth.
Dissenting against the decision were Richard Fisher of the Dallas Fed, Narayana Kocherlakota of Minneapolis and Charles Plosser of Philadelphia, who wanted to avoid any specific time reference on the low-rates pledge.
“The committee currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013,” the Fed said.
It also reiterated its policy of reinvesting the proceeds from bonds maturing in its portfolio, though it did not state a specific timeframe for such actions.
One analyst said the Fed’s language left open the possibility of a third round of QE.