Stocks cut losses after Fed announces plans to buy government debt to stimulate economy

Stocks cut losses on Fed’s economic stimulus plans

NEW YORK — The stock market had a half-hearted comeback Tuesday after the Federal Reserve announced it would take small steps to stimulate the economy.

The Dow Jones industrial average, down about 100 points before the Fed announced its plans, recovered to a loss of 54. The other major market indexes also bounced off of their lows. But investors were still cautious: The Dow was able to briefly show a gain, but fell back again as traders recognized that the Fed’s moves, while welcome, would be small and won’t cure the economy’s problems.

Losing stocks were ahead of advancers on the New York Stock Exchange by almost 3 to 1. And stocks considered safe bets in a weak economy, including health care and consumer products companies, were among the gainers.

The Fed, in a statement issued after a one-day policy meeting, said it will use money from its investments in mortgage securities to buy government debt on a small scale. Because rates on bonds and other debt fall as their prices rise, the Fed’s purchases should help send long term rates on mortgages and corporate debt slightly lower. And the Fed hopes, stimulate lending to consumers and businesses.

News that the Fed would be buying government debt, and in the process reduce the supply of Treasury issues on the market, sent Treasurys higher. The yield on the government’s 10-year note, which moves in the opposite direction from its price, fell to 2.75 percent from 2.82 percent before the announcement. The yield is used to help set rates on mortgages and other consumer loans.

Analysts said that while investors were hoping the Fed would take some steps to help the economy, the market recognizes the limitations of the central bank’s plans.

“We had an hour or so of rally, but then it backed off a bit,” said Dan Cook, Chicago-based senior market analyst with brokerage firm IG Markets. “Traders realized it’s not a game changer. It’s not going to pump up the market.”

The purchases of debt the Fed plans are known as “quantitative easing.” Economists estimate that the Fed will have about $10 billion a month to buy the debt. That is a small amount of money compared to the economy’s needs.

The Fed said it would use the proceeds it earns on mortgage bonds to buy two-year and 10-year Treasurys, and that it would buy an equal amount of government debt as existing bonds mature. The net effect is to keep its $2.3 trillion balance sheet steady, while shifting its holdings into more government debt. The Fed had hoped to roll back its debt holdings as the economy improved.

In 2009 and early 2010, the Fed bought $1.25 trillion in mortgage securities, $175 billion in mortgage debt from Fannie Mae and Freddie Mac, and $300 billion in government debt. In March, the Fed stopped buying new mortgage securities and Fannie and Freddie debt because the economy was clearly recovering.

Some analysts said the Fed is moving slowly in its current stimulus plans so investors don’t get the sense that the economy is more troubled than they have thought.

“There is only so much the Fed can do and right now it wanted to take baby steps in trying to provide additional liquidity without roiling the markets and scaring investors,” Michael Sheldon, chief market strategist at RDM Financial Group in Westport, Conn.

And some analysts are skeptical. Cook of IG Markets said that even if the Fed starts adding to its holdings of government debt, that would do little to boost the recovery. He noted that the Fed’s purchases last year pushed interest rates lower and fed the stock market’s big rally. But it didn’t lead to more loans for small businesses, a big source of new jobs.

“They can continue to buy Treasurys to keep borrowing costs down. But if the people who need credit don’t get it, it’s like knocking $50,000 off a Lamborghini. You’re still not going to be able to afford it,” Cook said.

The Dow closed down 54.50, or 0.5 percent, at 10,644.25 after the Fed’s mid-afternoon statement. The Standard & Poor’s 500 index fell 6.73, or 0.6 percent, to 1,121.06. The Nasdaq composite index closed down 28.52, or 1.2 percent, at 2,277.17.

NYSE consolidated volume, which includes shares traded on other exchanges, came to a light 4 billion shares, up from 3.3 billion Monday. Volume has been light all summer because investors don’t feel secure about the economy or the market. And the Fed’s move didn’t change their view.

Stock and bond investors looked past the Fed’s assessment of the economy that was included in the statement although it was bleaker than the central bank’s view in June. The Fed said, “the pace of economic recovery is likely to be more modest in the near term than had been anticipated.”

The dollar, which is hurt by a weak economy, fell after the Fed statement was released. The Fed indicated that interest rates will remain at extremely low levels for an extended period. And currencies tend to fall on low rates.

Stocks that traders call defensive, or that are expected to hold up even in a weak economy, were the market’s best performers after the Fed decision. That was another sign that investors weren’t euphoric about the Fed’s moves.

Health care stocks were among the market leaders. Merck & Co. rose 41 cents, or 1.2 percent, to $35.77. Eli Lilly & Co. rose 81 cents, or 2.2 percent, to $37.77.

Consumer products makers also rose. Colgate Palmolive rose $1.70, or 2.2 percent, to $77.97, while Procter & Gamble Co. rose 40 cents, or 0.7 percent, to $60.78.

Overseas, Hong Kong’s Hang Seng index fell 1.5 percent, while Japan’s Nikkei stock average fell 0.2 percent. Britain’s FTSE 100 fell 0.6 percent, Germany’s DAX index dropped 1 percent, and France’s CAC-40 fell 1.2 percent. All the markets were closed before the Fed announcement.