The Fed announced today that they would sell $400 billion of shorted dated securities in order to buy longer dated bonds. This is the much anticipated "Operation Twist" that we have discussed over the last several weeks. While the Fed believes this to be the "medicine" required to heal an ailing economy the reality is that with interest rates already at 50 year lows this program will have little to no effect on the economy or the markets.

The hope, of course, is that ultimately such a move will reduce rates on mortgages, consumer credit and business loans. However, what has gone unnoticed by the Fed, but well documented by us, is that "credit" is not the problem. The recent NFIB report made this abundantly clear as the number one concern for small businesses in "poor sales". Until final demand from consumers puts enough pressure on businesses that they are forced to expand production and employment - the demand for credit will remain non-existent. When it comes to mortgages - credit isn't the problem. It is demand and qualifications that is suppressing mortgages. Refinancing's currently make up the bulk of mortgage transactions but a refinance does not clear the market of the excess home inventory.

The Fed did make several comments regarding the ongoing weakness in the economy.

"Information received since the Federal Open Market Committee met in August indicates that economic growth remains slow. Recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated. Household spending has been increasing at only a modest pace in recent months despite some recovery in sales of motor vehicles as supply-chain disruptions eased"

As we have discussed in recent posts, as well as our weekly newsletter, the downside risks to the economy remain extremely elevated and a recession at this point is almost assured by 2012. The "recovery" from the Japan disruption has now been well factored in and the Fed, along with the Whitehouse, are now running out of excuses as to the economic malaise.

"Investment in nonresidential structures is still weak, and the housing sector remains depressed. However, business investment in equipment and software continues to expand. Inflation appears to have moderated since earlier in the year as prices of energy and some commodities have declined from their peaks. Longer-term inflation expectations have remained stable."

The issue with residential structures is that they continue to remain well contained at historically low levels more normally associated with recessions. While business investment in equipment and software has been fairly decent in recent quarters the dark side to that math is that the equipment and software have been used to reduce the need for employment by increasing productivity. Furthermore, even those investments have been deteriorating in recent reports as economic weakness seeps back into the overall environment.

Unfortunately, inflation has now exceeding the upper end of the Fed's target inflation range of 1-3%. This is one of the reasons why we have been saying that the Fed was unlikely to do a large QE as those injections have been directly responsible for rising commodity costs. With food and energy consuming more that 22% of wages and salaries the consumer can't take much more pressure with year over year wages declining.

Now for the "Punt"

"To support a stronger economic recovery and to help ensure that inflation, over time, is at levels consistent with the dual mandate, the Committee decided today to extend the average maturity of its holdings of securities. The Committee intends to purchase by the end of June 2012, $400 billion of Treasury securities with remaining maturities of three years or less. This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative. The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate."

In a loose, English, translation the Fed has basically stated they are out of options and all they can do now is hope that the government gets some form of stimulus passed and soon. Once this round of purchases is complete and the economy is staring at the front end of recession the Fed will realize that they are out of options.

However, as a testament to the economic realities that we face today, on my way back from lunch today I passed this group of girls giving out "free hugs". While in reality the Fed won't get much accomplished for the economy - "free hugs" are something that the average American can afford and benefit from - at least for a minute.