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To: Lucretius who wrote (229090)	3/18/2003 4:46:52 PM
From: yard_man	Read Replies (1) \| Respond to of 436258

I sure did -- now this carp is UFB real rates are already negative. Reuters Rates near zero, markets mull radical Fed weapons Tuesday March 18, 4:42 pm ET By Victoria Thieberger and Eric Burroughs NEW YORK, March 18 (Reuters) - Financial markets are starting to worry the Federal Reserve is getting closer to using up its rate-cut ammunition and may need to revive radical measures to stimulate growth. ADVERTISEMENT On Tuesday, the Fed signaled it was ready to cut interest rates quickly if a war on Iraq takes an economic toll, saying it would practice "heightened surveillance," a variation of language it has used in the past to suggest a possible move on rates. The Fed Funds rate is already at a four-decade low of 1.25 percent. One more cut, which markets see as a better-than-even bet in the next few months, would put the rate within striking distance of zero, leaving the Fed without its traditional monetary policy lever. "If they do 50 basis points more, that's probably it for traditional monetary policy. Then I think they would act in an unconventional way if further easing were needed," said Goldman Sachs chief economist Bill Dudley. Because nominal interest rates cannot fall below zero, if the economy is weak enough to warrant further stimulus, policy-makers would need to consider alternative tools such as buying Treasuries to lower long-term interest rates, something it has not done since World War Two. By lowering long-term rates, the Fed would hope to spark borrowing by companies for investment and ignite another wave of mortgage refinancings. After the recent batch of dismal economic news, investors have a greater sense of urgency about the sort of measures the Fed has suggested are still on the distant horizon. Indeed, some economists believe the Federal Reserve would not wait until the Fed Funds rate actually gets to zero before dusting off what it describes as "unconventional measures." A move to such a policy could come before the year is out. WHY WAIT UNTIL ZERO? Japan has bought government bonds for years in an attempt to increase the money supply, but with little impact on the economy because of structural problems in the Japanese banking system that hinder credit creation. Just this week, with its benchmark rates already close to zero, the Swiss National Bank said it could buy bonds to bring down longer-term rates. Those who argue that the Fed would not wait until the rate hits zero point to the devastating effect it would have on money market funds, which rely on a positive interest rate to cover their own operating costs. When Fed Chairman Alan Greenspan and one of the newest Fed governors, Ben Bernanke, discussed non-traditional policy tools recently, it was in the context of a hypothetical threat to the U.S economy from broad-based price declines, or deflation. While the threat seems remote, a recession triggered by war or extended economic weakness of the sort seen of late would increase the risk of deflation -- and of the Fed buying bonds. "It becomes an issue after the next cut -- not because the Fed is in such a hurry to do it, but because the market will begin to price it in," said Jon Blumenfeld, fixed-income strategist at Commerzbank Securities. In some respects, financial markets could do the Fed's work for it if investors push down longer-dated yields on the expectation of unorthodox Fed action -- thus providing the fillip to borrowing that the Fed would be hoping for. DUSTING OFF THE POLICY MANUAL The Fed would have to tread carefully in any attempt to lower long-term rates by actively intervening in the Treasury market, which trades roughly $370 billion each day, because the ramifications would be far-reaching in capital markets. Discussions within the Fed and among economists have revolved around two scenarios: either explicitly capping yields on specific maturities, like two-year notes, as has already been suggested by Bernanke; or conducting regular purchases of Treasuries without targeting a specific yield. Analysts believe the central bank would lean toward the second option for a variety of reasons. For one, targeting a specific yield would put the Fed's credibility on the line by allowing investors to see very clearly whether the central bank was succeeding. It could also invite speculators to test the Fed's mettle. "The more completely you describe your plans, the more you're inviting investors to measure the emperor's new clothes to see if they fit," said Lou Crandall, chief economist and money market specialist at Wrightson ICAP. "It's all about credibility. It's really important not to be seen to be missing your target," he said. Another reason is that targeting specific yields could be very disruptive to capital markets by severing the link between Treasuries and other fixed-income securities that defines much trading in markets, something known as "relative value." Crandall said the Fed would likely focus on buying a set amount of two-year notes and five-year notes on a weekly basis as a way of dragging down yields at the longer end of the yield curve, which gauges the returns on all Treasury maturities from three-months to 30 years. But some economists are not convinced the Fed would win the battle of lowering long-term rates if it tried to do so before taking the Fed Funds rate down to zero, because long-term rates are determined by benchmark short-term rates. Indeed, Bernanke's hypothetical discussion late last year was based on Fed Funds at zero. "It's almost a requirement before they pick up another weapon. They have to put down one, and that one has to be spent. They haven't spent their ammunition yet," said Drew Matus, financial market economist at Lehman Brothers.