Fed Announces Open-Ended Bond Purchases - QE3

The Federal Reserve on Thursday announced that it is launching a new program of open-ended bond purchases, so-called QE3, saying it will buy $40 billion of agency mortgage-backed securities each month as long as the economy needs it, starting Friday.

It's also keeping in place so-called Operation Twist, which consists of swapping short-dated securities for longer-term securities, as well as reinvesting the proceeds of maturing securities, so the central bank will be adding $85 billion of long-term securities each month through the end of the year.

The Fed is also extending its plan to keep interest rates exceptionally low until at least through mid-2015. Fed funds rates are currently targeted at a rate between 0% and 0.25%.

The Fed said it's acting "to support a stronger economic recovery" and expects the new program to put downward pressure on longer-term interest rates, support mortgage markets and help make financial conditions more accommodative.

U.S. stocks added to Thursday gains after the Federal Open Market Committee announced a new round of buying mortgage-backed securities.

Central Bank supplied $76.9 billion to Treasury in 2011

The central bank transferred $76.9 billion in earnings to the U.S. Treasury during 2011. The transfer is slightly less than the record $79.3 billion transferred in 2010.

The Federal Reserve said it earned $83.6 billion in interest income from its massive portfolio of securities, which includes Treasury debt and mortgage securities. The Fed has been buying assets as part of a quantitative-easing program, an unconventional monetary policy designed to lower long-term interest rates and boost economic growth.

The transfers in the past two years are about twice the pre-quantitative-easing levels. Under Fed policy, residual Fed earnings are distributed to Treasury after covering expenses.

The Fed pumps $1.2 trillion to the economy

The U.S. central bank would pump $1.2 trillion into economy to combat the worst global slowdown in decades, the Fed announced Wednesday, Mar. 18. The central bank’s plans to buy up to $300 billion long-term government bonds and some $750 billion in mortgage-backed securities, which would help revive the U.S. sagging housing market.

The Fed hasn't set out to influence long-term interest rates by buying long-term bonds since the 1960s.

By buying Treasurys and lifting the size for its programs to buy mortgage-backed securities and agency bonds, the Fed will boost money supply available for borrowing to combat the recession. The moves aims to lower mortgage rates and reduce the premium companies have to pay over the federal government to secure funding from the capital markets. The lower borrowing costs for consumers and companies are expected to prop up demand and spending in the U.S.

The Federal Reserve has been moving toward this quantitative easing policy since mid-September 2008. The policy is essentially required the Fed to print money to put the financial system back on its feet and jump-start the economy. But economists warned that such efforts could lead to long-term inflation, and could drive down the value of the dollar.

The Fed’s Open Market Committee also announced it would keep interest rates near zero, and said it expected its target interest rates to remain exceptionally low “for an extended period.” Interest rates in the U.S., the fed-funds target rate, has been in the range of 0%-0.25%. In all major economies, the interest rates have been pushed to ultra-low levels.

Moments after the Federal Reserve announced its plans, yields on the benchmark 10-year Treasury note posted their biggest drop in years as investors welcomed a big new buyer to the market for government debt. The central bank’s decision to fire up $1.2 trillion continued to sweep over world financial markets on Thursday, pushing the price of government bonds higher and dragging down the value of the dollar.

The Fed’s plan follows similar actions taken by central banks across the globe. The Bank of England is buying government securities, while the Swiss is selling francs to try to push down the value of their currency. The Bank of Japan announced Wednesday that it would also expand its purchase of government debt by almost 30 percent.

The markets are responding favorably to the U.S. Federal Reserve's bold $1.2 trillion spending plan. On Wall Street, stocks advanced on the day, but slipped on the next day. World stock markets were mostly higher the next day, Mar. 19.

The dollar has been sold off aggressively across the board in the wake of the Federal Reserve's decision. The dollar extended its decline against the euro, the yen and other major currencies on Thursday.

Another record low of mortgage rates

The average interest rates on U.S. 30-year fixed-rate mortgages fell for a ninth consecutive week, reaching their lowest level in 37 years, according to a survey released on Wednesday by home funding company Freddie Mac.

Interest rates on the 30-year fixed-rate mortgage dropped to an average of 5.10 percent for the week ending Dec. 31, down from the previous week's 5.14 percent, Freddie Mac said. The 30-year fixed-rate mortgage has not been lower since Freddie Mac started the Primary Mortgage Market Survey in 1971.

Mortgage rates have dropped dramatically ever since the Federal Reserve unveiled a plan last month to buy up to $500 billion of mortgage securities backed by government-sponsored enterprises, Fannie Mae, Freddie Mac, and Ginnie Mae. The program also entails buying up to $100 billion of debt issued by Fannie Mae, Freddie Mac and the Federal Home Loan Banks. The Fed on Dec. 30 moved forward aggressively with an effort to drive down mortgage costs, setting a goal of buying $500 billion in mortgage-backed securities by mid-2009.

The housing market is in the worst downturn since the Great Depression as a huge supply of unsold homes, tighter lending standards and record foreclosures push down home prices. House prices fell 18% over the 12-month period ending in October, according to the S&P/Case-Shiller 20-city composite index. From its peak set in July 2006, the composite index is down 23.4%

An improvement in the housing market could portend a turnaround for the world's largest economy, which has been in a recession since late last year. The battered housing market is critical to the U.S. economy.

Mortgage rate at 37-year low

Interest rates for the benchmark 30-year fixed-rate mortgage tumbled to a national average 5.17 percent this week, the lowest level since Freddie Mac began its weekly rate survey in 1971. The decline was supported by the Federal Reserve announcement on Dec. 16, when it cut the federal funds target rate to a record low, a range of zero to 0.25 percent, and stated it stood ready to expand its purchases of mortgage-related assets as conditions warrant.

The 30-year fixed-rate mortgage fell for the seventh consecutive week, dropping from 5.47 percent a week ago. A year ago the 30-year averaged 6.14 percent. It took a national average 0.7 point to obtain that rate, though; a point is 1 percent of the loan amount, paid upfront as prepaid interest.

Rates on other types of mortgages also dropped this week, although not as much as the 30-year mortgage.

The 15-year fixed-rate mortgage averaged 4.92 percent with an average 0.7 point, down from last week when it averaged 5.20 percent. A year ago the 15-year loan averaged 5.79 percent. The 15-year mortgage has not been lower since April 1, 2004, when it averaged 4.84 percent.

Five-year Treasury-indexed hybrid adjustable-rate mortgages averaged 5.60 percent, with an average 0.6 point, down from last week when it averaged 5.82 percent. A year ago, the 5-year ARM averaged 5.90 percent.

One-year Treasury-indexed ARMs averaged 4.94 percent this week with an average 0.5 point, down from last week when it averaged 5.09 percent. At this time last year, the 1-year ARM averaged 5.51 percent.