Fed Expected to Stand Pat Next Week as Election Nears

Friday, 19 Oct 2012 12:35 PM

 

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The U.S. Federal Reserve is likely to hold off from taking fresh steps at a policy meeting next week, opting to review the impact of the significant action it took last month and keep a low profile in its last gathering before the Nov. 6 general election.

Economic data has improved since the central bank announced a third round of bond purchases in September, but the jobless rate is still painfully high at 7.8 percent and gives the Fed no reason to scale back its aggressive economic stimulus.

"The Fed probably wished that they didn't have to meet next week," said Torsten Slok, chief international economist at Deutsche Bank Securities in New York. "First, it is just in front of the election and second, they just took significant action at their last meeting, and they now want to lean back and monitor how the economy responds."

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

The central bank's policy-setting Federal Open Market Committee holds a two-day meeting starting on Tuesday, and is scheduled to release a statement on its policy deliberations at around 2:15 p.m. (1815 GMT) on Wednesday.

At its last meeting in September, the Fed announced it would buy $40 billion of mortgage-backed bonds per month until the outlook for the U.S. job market improved substantially. It said an easy monetary policy would be appropriate for a "considerable time" even after the recovery strengthened.

The new program, which aims to drive down borrowing costs, builds upon the $2.3 trillion in securities the Fed has already added to its portfolio, and it drew scrutiny from Republicans who worry the central bank is flirting with inflation.

With its upcoming meeting just two weeks before the presidential and congressional elections, the latest step from the Fed allows it to hold fire this time to avoid any impression it was trying to help one party or the other.

Since the central bank last met, the government has reported a drop in the unemployment rate and a second strong month for retail sales. Consumer sentiment and housing activity have also picked up, although signals from businesses remain mixed.

Nor has the inflation outlook suffered. Inflation expectations, as implied by the spread between 10-year inflation-protected securities and regular government debt, rose immediately after the September announcement, but have since receded. Currently, the spread stands around 2.5 percentage points, not far from the Fed's 2 percent inflation target.

At the same time, the spread between mortgage-backed bonds and the 30-year Treasury bond is down about a quarter percentage point. The decline has helped drive mortgage rates to record lows and has provided an underpinning to the growing momentum of the still-battered housing sector.

STILL NOT DONE

Although the Fed's statement on Wednesday is not likely to yield any surprises, officials still have plenty to talk about.

"I don't think they are done, in terms of either a change in policy (on) asset purchases, or in terms of strategy of how they present what they are trying to do," said Michael Feroli, an economist at JPMorgan in New York. "These things are all still in the oven, but not yet thoroughly cooked."

Minutes of the Fed's September gathering showed that many policymakers favor adopting numerical thresholds for unemployment and inflation to help determine when to finally raise interest rates from near zero. The Fed has kept overnight rates pressed to the floor since December 2008.

Numerical guidelines would help officials move away from a current commitment to hold rates steady until mid-2015, which some find too restrictive because it is linked to a date, rather than a specific state of the economy.

In addition, next week's meeting will also review work done on FOMC consensus forecasts, which would be a way to provide the public with a sense of the center of gravity of the committee's view on the economy and likely path of future interest rates.

Discussions of both would help tee up the final policy gathering of the year on Dec. 11-12 as a more promising occasion to unveil additional policy steps, including what to do when the Fed's "Operation Twist" program expires at the end of the year.

In that program, the Fed has been selling $45 billion in short-term debt every month and buying a similar amount of longer-dated securities to try to drive long-term borrowing costs down.

Fed watchers think it will extend the program in December, although the uncertainty around the year-end fiscal cliff of scheduled tax hikes and government spending cuts could lead officials to hold off until they have a clearer sense of how heavily fiscal policy may weigh on the economy next year.

The Fed has warned the economy could tip back into recession if lawmakers fail to avoid the full force of the end of Bush-era tax cuts and the automatic reductions in government spending that were put in place in an effort to force a long-term budget-cutting deal.

"We wouldn't be surprised to see the Fed adding, say, $40 billion of monthly long-term Treasury securities purchases at its mid-December meeting," Paul Ashworth at Capital Economics wrote in a note to clients.

"But the complicating factor in the timing is the fiscal cliff. ... This is a case for the Fed waiting to see which way fiscal policy breaks before tweaking monetary policy again."

Editor's Note: Economist Unapologetically Calls Out Bernanke, Obama for Mishandling Economy. See What They Did

© 2014 Thomson/Reuters. All rights reserved.

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