What the Fed Move Means

  Talk about a shot in the arm. The Federal Reserve's Sept. 13 announcement of a third round   of "quantitative easing" sent some mortgage-bond funds to their biggest one-day gains in a year.

The Fed said it would buy mortgage-backed securities, or MBS, for an indefinite period to bolster the economy. That could spell an opportunity for investors—and might warrant stocking up on funds that hold the securities, say analysts.

While "QE3" was anticipated, the particulars of the program were something new. Instead of committing to buy a fixed amount of Treasury debt—as it did when announcing QE2 in November 2010—the Fed left this round of easing open-ended.

The Fed says it plans each month to buy $40 billion of agency mortgage-backed securities, which are supported by government-sponsored enterprises such as Fannie Mae and Freddie Mac . The Fed says the buying will continue until the labor market improves substantially.

But because it is unclear how long the Fed will continue its bond-purchasing program, most segments of the mortgage market seem to have priced in only about a year's worth of Fed purchases, says Steven Abrahams, head of MBS and securitization research at Deutsche Bank.

The mortgage market also will be hypersensitive to changes in the labor market, says Mr. Abrahams. When unemployment claims or payrolls reports are unexpectedly weak, traders will expect the Fed's bond-buying program to continue longer, which will push mortgage bond prices up, he says. Prices could fall after strong reports. (Bond yields move in the opposite direction of prices.)

Fed Pulls Trigger, To Buy Mortgages in Effort to Lower Rates

The Federal Reserve fulfilled expectations of more stimulus for the faltering economy, taking aim now at driving down mortgage rates until an improvement in unemployment that the central bank says will be a problem for several years.

The Fed said it will buy $40 billion of mortgage-backed securities per month in an attempt to foster a nascent recovery in the real estate market. The purchases will be open-ended, meaning that they will continue until the Fed is satisfied that economic conditions, primarily in unemployment, improve.

There's strong hints that they'll do Treasuries next," Joe LaVorgna, chief economist at Deutsche Bank Advisors, said in a phone interview from London. "They're pulling out all the stops to try to get this economy to gain some traction and, most important, to get unemployment down."

"The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions," the Open Market Committee said in a statement. 

As a follow-up to the statement, the Fed released its latest economic projections, which foresee slow growth including a jobless rate that stays above 7 percent into 2014. The economic projections expect growth to remain slow but to improve due to the stimulate measures announced Thursday.

In addition, the Fed said it will continue its program of selling shorter-dated government debt and buying longer-term securities, a mechanism known as Operation Twist. It also will continue its policy of reinvesting principal payments from agency debt and mortgage-backed securities back into mortgages.

The Fed left its funds rate unchanged at near-zero but offered one change in that regard, saying the rate would stay at "exceptionally low levels" until at least mid-2015.

Jobs Rut Tips Scale in Favor of Fed Stimulus

The Federal Reserve looks set to launch a third round of bond purchases this week to try to drive borrowing costs lower and breathe more life into an economy that is not growing fast enough to lower unemployment.

Despite political opposition and some internal dissent, economists said a weak report on jobs growth for August was likely enough to convince the U.S. central bank a looser monetary policy was needed.

"The Federal Reserve will ease again," said Sung Won Sohn, an economics professor at California State University Channel Islands in Camarillo, California. "There are too many people without jobs and the unemployment rate is too high at this stage of an economic recovery."

The economy created just 96,000 jobs in August, well below expectations and less than what is needed to keep up with population growth, a government report showed on Friday.

While the jobless rate declined to 8.1 percent from 8.3 percent, that was only because Americans gave up the hunt for work in droves, further bolstering the case for more bond buying, or quantitative easing. "This is certainly a disappointing report and increases the odds for QE, which were already reasonably high," said David Sloan, an economist at 4CAST Ltd.

In remarks late last month, Fed Chairman Ben Bernanke laid the groundwork for a third round of bond purchases, or QE3, by calling the stagnation in the labor market "a grave concern." As part of any new bond buying, many economists think the Fed will return to the housing-related debt purchases it resorted to during the damaging 2007-2009 recession, perhaps buying a mix of mortgage-backed securities and U.S. Treasuries.

Some hope MBS purchases would drive mortgage rates lower and give an extra push to a housing sector that has shown some signs of life recently, boosting economic growth.

Bernanke Says Fed Ready to Act But Short on Specifics

Federal Reserve Chairman Ben Bernanke on Friday left the door wide open to a further easing of monetary policy, saying the stagnation in the U.S. labor market was a "grave concern," but he stopped short of providing a clear signal of imminent action.

His stark language gave a temporary lift to U.S. stocks, but economists walked away from the Fed chairman's remarks still divided over whether the central bank would launch a fresh round of bond purchases at its upcoming meeting in September.

Bernanke said the Fed had to weigh the costs as well as the benefits of more monetary stimulus, although he hinted the costs were likely worthwhile.

"As we assess the benefits and costs of alternative policy approaches ... we must not lose sight of the daunting economic challenges that confront our nation," Bernanke said at the Kansas City Fed's annual Jackson Hole symposium.

"Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."

That was a somewhat weaker hint of policy easing than the minutes of the Fed's last policy meeting had delivered, but Bernanke's dour economic assessment left few doubts where his sympathy lay.