In their release after meeting on Tuesday, August 10, the Federal Reserve Open Market Committee (FOMC) indicated they would now begin to purchase long-term Treasury bonds with the maturity proceeds of the approximately $1.3 trillion of mortgage-backed securities the Fed purchased during the 2008-2009 credit crisis. Prior to this FOMC decision, the Fed plan was to let the mortgage-backed securities just roll off as they matured and gradually remove that stimulus. The Fed made clear their concerns in their published statement after the meeting with language of "the pace of recovery in output and employment has slowed in recent months".
The fear now seems to be the possibility of Japanese-style deflation, with the U.S. 10-year Treasury now yielding 2.8% as compared to a 2010 rate peak of about 4% in April. Note that even at 2.8% U.S. rates are 1.7% above comparable government securities in Japan, so there is still far to travel to reach those levels. Further, in Japan the average monthly inflation since end of 1992 has been minus 0.1%, while in the U.S. the June 2010 data showed annual core CPI (excluding food and energy) of 1%, so we still aren't seeing U.S. deflation.
It is comforting to some that the Fed is tuned into slowing growth and deflation risks. Others see the Fed as ineffective as they can't force monetary stimulus into a banking system where credit standards have tightened and loan demand declined. Still others see the Fed actions to fight possible deflation in the short-term as leading to U.S. dollar currency devaluation and inflation in the long-term. No one can clearly see where this is all going and investors have to be careful not to be whipsawed as the markets react to the latest news and government policy actions.
