U.S. Fed announces new stimulus

The U.S. Federal Reserve Wednesday unveiled a widely-anticipated economic stimulus plan investors have come to nickname "Operation Twist."
The Federal Reserve Wednesday was widely expected to announce its third program of bond-buying in recent history, which is aimed at stimulating spending and investment. (Charles Dharapak/Associated Press)

The U.S. Federal Reserve Wednesday unveiled a widely-anticipated economic stimulus plan investors have come to nickname "Operation Twist."

The plan will have the Fed sell $400 billion US in bonds maturing in the next three years from its $2.87 trillion portfolio and use the proceeds to buy U.S. Treasurys with six-to-30 year terms.

Economists have named the move after a similar operation by the Kennedy administration in 1961 to cut long-term rates without touching short-term rates.

Back then, Chubby Checker's Twist was a dance craze.

The intention is to lead long-term borrowing rates lower and encourage people and businesses to spend and invest more.

Whether it has much effect on long-term Treasury rates, which are already low, is debatable.

Inflation feared

On Monday, the four highest-ranking Republicans in Congress sent Bernanke a letter cautioning the Fed against taking further steps to lower interest rates. Their letter suggested that lower rates could escalate the risk of high inflation.

And three members of the Fed's monetary policy committeee dissented from its decision Wednesday, also out of fears of inflation. That was the most negative votes on a Fed decision in nearly two decades.

And some economists argue there's little evidence to suggest lower long-term interest rates do much good.

The move is the Fed’s third program of Treasury bond purchases in recent history and came on top of its unprecedented promise on August 9 to keep interest rates low until 2013.

U.S. stocks sold off, apparently unconvinced that the Fed's move will be enough to spur recovery.

The Dow Jones industrials fell 283.82 points, or 2.5 per cent, to 11,124.84, the Nasdaq composite index was down 52.05 points, or two per cent, to 2,538.19 and the S&P 500 index dipped 35.33 points, or 2.9 per cent, to 1,166.76.

 "At the end of the day, I'm not sure there is much more they can do, they've already pulled down yields by saying that they were going to keep short-term interest rates at effectively zero for another two years," said Norman Raschkowan, North American strategist at Mackenzie Financial Corp.

IMF lowers growth forecast

"The bigger issue now is the political mess in the U.S. and Europe and the fact you need people to regain confidence in the political leadership and the ability of politicians to work together to address the problems."

The Fed's announcement came a day after the International Monetary Fund lowered its forecast for U.S. growth this year.

The IMF expects the U.S. economy to grow only 1.5 per cent this year and 1.8 per cent in 2012. In June, it had forecast 2.5 per cent growth in 2011 and 2.7 per cent in 2012.

The IMF also lowered its outlook for the 17 countries that use the euro because it fears Greece will default on its debt.

If Greece or Italy were to default, European banks that have lent money to the countries could lose billions of dollars.

That could hurt the European banking system and have repercussions for U.S. banks, which have lent billions to their European counterparts.

Investors are concerned that a default in Europe could cause a lending crisis similar to what happened after the collapse of Lehman Brothers in 2008.

With files from The Associated Press