Fed Signals Stronger Economy Won't Slow Plan to Buy $600 Billion in Bonds

Federal Reserve policy makers indicated that signs of economic strength won’t deter them from pumping money into the financial system so long as unemployment remains elevated.

The Federal Open Market Committee said yesterday after its final meeting of 2010 that growth is “insufficient to bring down unemployment” and inflation has “continued to trend lower.” U.S. central bankers affirmed a plan to buy $600 billion of bonds through June and renewed their pledge for an “extended period” of low interest rates.

Stocks climbed and Treasuries fell as continued Fed stimulus and better-than-forecast retail sales boosted the outlook for growth in the coming year. Policy makers led by Chairman Ben S. Bernanke are defying Republican criticism that their policy will fuel inflation and asset price bubbles to focus on cutting an unemployment rate that has stayed above 9.4 percent since May 2009.

“The clear message is there is no rethinking of the program, no consideration of backing off,” said Jim O’Sullivan, global chief economist at MF Global Ltd. in New York. “Arguably they downplayed what have clearly been better growth data.”

Signs of economic strength, along with prospects for additional fiscal stimulus, have pushed Treasury yields higher, with the 10-year yield rising to 3.47 percent yesterday from 2.57 percent on Nov. 3, the day the second round of easing was announced. The Dow Jones Industrial Average reached the highest level since the Sep. 15, 2008 bankruptcy of Lehman Brothers Holdings Inc., closing at 11,476.54 yesterday.

Dollar’s Climb

The dollar has climbed 3.9 percent against a basket of six currencies, while inflation expectations for the next five years, as measured by the breakeven rate between nominal and inflation-indexed bonds, rose to 1.63 percent yesterday from 1.47 percent on Nov. 3.

The Fed statement should “guide market participants to focusing on the unemployment rate as the relevant measure for whether the economy is picking up fast enough,” said Dean Maki, chief U.S. economist at Barclays Capital in New York. “The economic data have clearly been improving and the Fed could have sounded much more upbeat than it did.”

A Dec. 3 Labor Department report showed the unemployment rate rose to 9.8 percent from 9.6 percent as the economy added only 39,000 jobs in November. Other reports in recent weeks signaled an improving economy, such as a greater-than-expected increase in retail sales, the 16th consecutive month of expansion in manufacturing, and consumer confidence at a six- month high.

‘Tight Credit’

The FOMC statement said “household spending is increasing at a moderate pace, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.”

Fed officials yesterday left their target for the federal funds rate, which covers overnight interbank loans, in a range of zero to 0.25 percent, marking two years of the policy. The central bank is likely to wait until the first quarter of 2012 to raise the rate, based on the median estimate in a Dec. 2-8 Bloomberg News survey of economists.

The $600 billion of purchases are in addition to long-term Treasuries the Fed is buying by reinvesting proceeds from maturing mortgage debt, a policy begun in August. Combined purchases through June will total $850 billion to $900 billion, or about $110 billion a month, the Fed said Nov. 3. Policy makers reiterated yesterday they will “regularly review” the purchase program and adjust it as needed.

The central bank has bought $114.1 billion of Treasuries since Nov. 12, under the program dubbed QE2 for the second round of so-called quantitative easing. The Fed bought $1.7 trillion of mortgage debt and Treasuries in the first round through March 2010.

Most Dissents

Kansas City Fed President Thomas Hoenig, the longest- serving policy maker, voted against the FOMC decision for the eighth straight time, reiterating his view that the “continued high level of monetary accommodation” may eventually “destabilize the economy.” He tied former Governor Henry Wallich’s record in 1980 for most dissents in one year.

“It was notable that the only acknowledgement of stronger economic data and upward revisions to 2011 from fiscal policy was in Tom’s dissent,” said Diane Swonk, chief economist for Mesirow Financial Inc. in Chicago. “It would take a lot of good economic news to get Bernanke to change his mind” about the stimulus plan.

The roster of voting members on the FOMC will change next month to include policy makers who have voiced doubts about the asset purchase program.

Raised Concerns

Minneapolis Fed President Narayana Kocherlakota, Richard Fisher of Dallas and Charles Plosser of Philadelphia have raised concerns about the effectiveness of the Fed’s return to quantitative easing, although Kocherlakota said in a Nov. 18 speech that he supported the policy as “a move in the right direction.”

Chicago Fed President Charles Evans, also set to become a voting member, said in October the central bank would need to buy securities on a large scale several times to carry out his preferred strategy of aiming to raise inflation temporarily.

Policy makers said in their statement today they need to guide the economy more in line with the their congressionally determined mission.

“The unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate,” the Fed said, repeating language from last month’s statement.

Slowest Pace

Inflation excluding food and fuel costs, as measured by the personal consumption expenditures price index, fell to 0.9 percent in October, the slowest pace since records began in 1960. Central bankers prefer a long-run rate of 1.6 percent to 2 percent for the so-called core PCE gauge.

Republican lawmakers, including Indiana Representative Mike Pence and Tennessee Senator Bob Corker, want to jettison the half of the Fed’s legislative mandate that focuses on maximum employment so as to concentrate on stable prices alone. Texas Representative Ron Paul, author of the book “End the Fed,” is set to chair a subcommittee that oversees the Fed next year.

With the greater political pressure, “there’s going to be a lot more noise and controversy around the Fed’s policies,” said Julia Coronado, chief economist for North America at BNP Paribas in New York.

“This is Chairman Bernanke’s Volcker moment, when he may have to engage in policies that are unpopular but what he thinks he needs to do for the good of the economy,” she said. Paul Volcker, Fed chairman from 1979 to 1987, increased interest rates to as high as 20 percent to tame an annual inflation rate approaching 15 percent.

To contact the reporter on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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