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Fed to maintain aggressive stimulus policy

fedThe Federal Reserve is expected to maintain its massive bond-buying campaign when it concludes a two-day meeting on Wednesday and may point to softer readings on the U.S. economy to signal that the policy will be extended into 2014.

The central bank, which will announce its policy decision at 2 p.m., has held interest rates near zero since late 2008 and has quadrupled the size of its balance sheet to more than $3.7 trillion through three rounds of bond buying. The purchases are aimed at holding down longer-term borrowing costs.

It shocked markets in September by opting to keep buying bonds at an unchanged pace, after allowing a perception to harden over the summer that it was ready to start scaling back the purchases. The central bank’s caution has since been vindicated.

Consumer and business confidence has been dented by a bitter budget battle in Washington that triggered a 16-day government shutdown earlier this month and pushed the nation to the brink of a potentially devastating debt default.

“I think you will certainly see a change in tone in the statement,” said Scott Anderson, chief economist at Bank of the West in San Francisco.

Like many economists, Anderson now thinks the Fed will keep buying bonds at an $85 billion monthly pace until March.

Data on hiring, factory output and home sales in September that have tumbled in over the last couple of weeks suggest the economy lost a step even before the government shut down. Readings on consumer confidence this month have shown the fiscal standoff rattled households.

Tepid demand is also keeping inflation under wraps, which is yet another factor that could help convince the Fed’s policy-setting Federal Open Market Committee to maintain its asset purchase course. Over the past 12 months, producer prices rose just 0.3 percent, the smallest gain since 2009.

“The October government shutdown has undoubtedly slowed down the economy in the fourth quarter,” economists at Rabobank wrote in a note to clients. “It will be 2014 before we are able to see a number of months of economic data that may convince the FOMC that the recovery is continuing at a solid pace.”

The soft tone in the data has led financial markets to recalibrate forecasts for a tapering in the Fed’s bond purchases. It has also pushed rate hike expectations back into mid-2015 at the earliest.

“It is looking like most of the hikes would happen in 2016,” said Anderson, adding that the shift in expectations has helped pull bond yields lower.

Futures markets indicate a 52 percent chance of the first quarter-point rate hike by April 2015; that rises to 96 percent by September 2015. Yields on the 10-year U.S. Treasury note have fallen back to 2.50 percent, compared with almost 3 percent in early September.


A further wrinkle in the Fed’s deliberations is the upcoming leadership transition at the central bank. Earlier this month, President Barack Obama nominated Fed Vice Chair Janet Yellen to replace Ben Bernanke at the institution’s helm when his term expires on January 31.

Some economists think Bernanke would like to begin reducing the bond purchases on his watch, provided the economic data was sufficiently encouraging.

But if policymakers wait until March, it would presumably give Yellen an opportunity to lean against criticism that she is too dovish in how she weighs unemployment versus inflation.

That question will be a central theme of her confirmation hearing before the U.S. Senate Banking Committee. The hearing likely be held on November 14.

Yellen is expected to win confirmation from the Senate but will likely face tough questions from Republicans critical of the Fed’s ultra-easy monetary policy, which they say risks financial instability and future inflation.

The banking panel needs to vet her nomination before it goes before the full Senate for final approval.-Reuters