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Fed Plan No Magic Bullet

The Fed's newest bond-buying plan has the potential to help, but investors should consider the risks before becoming too exuberant.

Jeremy Glaser 03.10.2012

After months of fevered speculation, the Federal Reserve on September 13th announced its new bond-buying program aimed at boosting employment, assisting the housing market, and trying to help the economy grow strongly again. The market cheered the move. But will the program work, and is the enthusiasm warranted? Certainly, the move could make a discernable difference in the economy. This of course doesn't mean that more easing is an economic panacea and has no risks, or that the Fed can do all of the heavy lifting to boost the economy.

Building Up the Housing Sector
Unlike pervious easing plans, this new one is explicitly focused on employment. This shouldn't be a huge shock. The Fed has a dual mandate to both keep inflation low and employment high, and only one of those is a major problem at the moment. One of the key ways the Fed is planning to boost job growth is by stimulating the long-suffering housing sector. By buying $40 billion of mortgage-backed securities every month, the central bank is hoping to push mortgage rates even lower and entice more people into the housing market. The hope is that this will jump-start construction and begin to bring back some of the housing jobs that were lost during the bust. This isn't a crazy idea. Housing is one part of the economy that can absorb a huge number of new jobs, it is already showing emerging signs of strength, and it is highly leveraged to the financing environment.

Beyond just targeting a potentially job-rich sector, the Fed is explicitly tying the end of the program to an improvement in the labor market. It will keep buying bonds every month until the outlook for the labor market improves "substantially." By explicitly tying the program to the labor market, Fed officials are making it crystal clear that they see the weak job market as a major problem and that they will remain in the market until it is fixed or inflation gets out of control (more on that later). This open-ended commitment is a departure from previous rounds of stimulus where the Fed committed to a prescribed dollar amount of buying. In the past the market would have to wonder when (or if) the Fed was going to act again. If you trust the Fed's commitment to stand by its policy statements, then a lot of those questions and uncertainty disappear with this longer-term commitment. Add in the pledge to keep rates low through 2015, and it appears that this program is an even stronger commitment to act than the Fed showed in the first two rounds of easing.

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About Author

Jeremy Glaser  Jeremy Glaser is the Markets Editor for Morningstar.com.

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