Wall Street Rallies in Response to Fed’s Latest Credit Crisis Plan

Wall Street responded positively to the announcement by the Federal Reserve that it plans to buy another $750 billion in mortgage-backed securities and $300 billion in long-term U.S. treasuries over the next six months in a renewed effort to get credit flowing again. The plan was revealed following the latest meeting of the Federal Open Market Committee, the Fed’s policymaking committee that determines interest rates. While the news was not totally unexpected, due to the fact that the Fed had previously stated it may consider following this course, stocks nonetheless turned higher on the strength of the announcement. The Dow picked up by 1.2 percent on Wednesday, with both the S&P and Nasdaq gaining more than two percent.

The rally on Wall Street occurred despite the fact that the Federal Reserve did not sugar-coat the realities of the U.S. economy, warning in its statement that the economy had deteriorated since its January meeting, pointing out that further job losses are inevitable and the value of stocks and homes are likely to decline further, while tight credit conditions and restricted consumer spending will continue.

With bond prices and rates moving in opposite directions, the surge in bond prices following the Fed’s announcement resulted in longer-term Treasuries falling sharply, with both the ten-year note and thirty-year notes falling 0.3 percentage points. The Fed also took the decision to leave interest rates unchanged at the rate of 0 to 0.25 percent, which is what they have been sitting at since December 2008.

The Fed anticipates that inflation will remain in a state which the report described as “subdued”. However, in light of the fact that the Fed is essentially creating new money to buy the securities and bonds, many have expressed concern that the significant increase in the money supply will result in increased inflation levels in the future. To underscore these concerns, while markets rallied, the U.S. dollar hit a two month low against the euro, as well as losing ground against other major currencies, with a weaker dollar translating into more expensive imported goods, including oil.

While there are pros and cons to any decision taken, especially in a volatile market, analysts generally agree that the message sent out by the Federal Reserve indicates that the central bank is prepared to go to great lengths to stabilize the economy, and still has the resources at its disposal to achieve its goals.