Federal Reserve Frets Over Fiscal Recklessness Behind Calm of 0.09% Yield
Federal Reserve Chairman Ben S. Bernanke is stepping up his call for the government to rein in the federal deficit -- just not now.
The central bank chief and his lieutenants are expressing concern that Congress’s failure to close what Dallas Fed President Richard Fisher called the nation’s “fiscal sinkhole” puts the economy at risk. At the same time, they say that acting too quickly may choke off a recovery hobbled by an unemployment rate above 9 percent.
Concern that government spending cuts will inhibit economic growth may prompt the Fed to maintain record stimulus well beyond the completion of its $600 billion bond purchase program this month, said Dean Maki of Barclays Capital. Should the economy weaken further, there’s little more the Fed can do to spur growth and create jobs with interest rates near zero and the balance sheet at a record $2.83 trillion.
“The Fed is not inclined to do more easing in the form of asset purchases, and it would create something of a dilemma for them if there’s such a dramatic near-term fiscal tightening put in place that it prevented the Fed from achieving its mandate” for full employment, said Maki, chief U.S. economist at Barclays in New York. The prospect of fiscal tightening “certainly is a factor pushing the Fed to delay its exit strategy.”
The Federal Open Market Committee’s meeting yesterday and today in Washington was the last one before Aug. 2, when the Treasury Department says it will no longer be able to borrow to finance government operations unless lawmakers agree to raise the $14.3 trillion debt ceiling.
Policy makers today affirmed a decision to end bond purchases and repeated their pledge to keep the benchmark interest rate close to zero for an “extended period.”
“The economic recovery is continuing at a moderate pace, though somewhat more slowly than the committee would like,” the FOMC said in a statement today. Bernanke is scheduled to meet the press at 2:15 p.m.
Lawmakers such as Senator Pat Toomey, Republican of Pennsylvania, and Senator Ben Nelson, Democrat of Nebraska, are insisting on spending cuts as a condition for an agreement to raise the debt limit. Bernanke, in a June 14 speech, said the limit shouldn’t be used as a bargaining chip to force cuts, and that failing to raise the cap could cause “severe disruptions” in financial markets.
“I urge the Congress and the administration to work in good faith to quickly develop and implement a credible plan to achieve long-term sustainability,” Bernanke said.
Such a plan “would not only enhance economic performance in the long run, but could also yield near-term benefits by leading to lower long-term interest rates and increased consumer and business confidence,” he said.
So far, the concern about the deficit hasn’t driven U.S. borrowing costs to above-average levels. The yield on the benchmark 10-year Treasury note was 2.98 percent at 1:40 p.m. in New York today. That’s below the average of 7 percent since 1980 and the average of 5.48 percent in the 1998 through 2001 period, according to Bloomberg Bond Trader. Treasury six-month bill rates were at 0.08 percent.
Lawmakers and investors shouldn’t take comfort in low U.S. borrowing costs because markets are often “complacent” about the risk from excessive deficit spending, said James Bullard, president of the Federal Reserve Bank of St. Louis.
“When it does blow up it will be too late,” Bullard said in an interview last month in New York. “When markets lose confidence in the U.S. and say that they don’t trust us any more, rates will skyrocket and the crisis will be upon you.”
He cited Europe as an example. Greek 10-year bond yields were 17 percent yesterday, up from 5.77 percent on Jan. 1, 2010. The cost of insuring against default on Greek, Irish and Portuguese government debt surged to records in the last week after European Union talks stalled on a second bailout for Greece and police deployed tear gas to break up anti-government protests in Athens.
Some Republican lawmakers, including Representative Joe Walsh of Illinois, have scoffed at warnings that failing to raise the debt limit would trigger a financial catastrophe. Obligations to bondholders can be met with the tax revenue that will continue to pour into the Treasury, and the government’s other bills can be delayed or cut without panicking financial markets, the Republicans say.
Bernanke last week dismissed notions that Treasury payments could be “prioritized” to avoid a default, saying delaying any government payments could create “serious concern” about the nation’s creditworthiness.
Politics of Budget
The Fed is “concerned with the playing around and the politics of the budget,” said Robert Eisenbeis, former head of research at the Federal Reserve Bank of Atlanta and now chief monetary economist at Sarasota, Florida-based Cumberland Advisors Inc. “Their belief is that fiscal stimulus is the way to get out and get the economy growing faster.”
While Fed officials are urging lawmakers to adopt a long- term plan to lower budget deficits and the debt, they are warning against cutting too quickly.
“No issue is more important than a credible commitment for getting our fiscal house in order, but at a pace that does not forestall a sustained recovery,” William C. Dudley, president of the Federal Reserve Bank of New York, said in a June 7 speech.
Companies boosted payrolls in May at the slowest pace since June 2010, Labor Department figures released June 3 showed. Autos sold last month at the weakest pace since September, retail sales dropped for the first time in 11 months and manufacturing grew at the slowest pace since September 2009, other data showed this month.
The Standard & Poor’s 500 Index of stocks declined 5 percent to 1,295.52 yesterday from its 2011 peak on April 29 as concern also escalated that Greece would default on its debt, sparking a European crisis that would hamper the U.S. recovery. Former Federal Reserve Chairman Alan Greenspan told Charlie Rose last week that Greece’s crisis has the potential to push the U.S. into another recession.
Bernanke, in a speech on June 7, said that “accommodative monetary policies are still needed” to boost a recovery that’s “frustratingly slow.”
Policy makers “are saying we want to maintain what we’ve got for a while and we can’t afford to pull away any of the stimulus right now,” said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut.
Threat to Recovery
Budget cuts threaten to further sap the recovery, says Ethan Harris, head of developed-markets economic research at Bank of America Merrill Lynch in New York.
Harris forecasts that a fiscal contraction, including $50 billion in spending cuts, will reduce economic growth by one percentage point next year, to 3 percent. That assumes the U.S. doesn’t default on its debt, he said.
“The Fed is worried they’re in the process of losing their partner in fighting this bad economy,” Harris said. “That’s the problem with premature fiscal tightening -- it’s not like we’re in a normal world where the Fed’s got plenty of ammunition and political support to do the right thing.”
The Fed’s Nov. 3 decision to buy $600 billion of bonds -- dubbed QE2 for the second round of quantitative easing --sparked the harshest political backlash in three decades.
Republican lawmakers, including House Speaker John Boehner of Ohio, said the program risks accelerating inflation, weakening the dollar and fueling asset bubbles. The last time the Fed faced such a backlash was in the late 1970s and early 1980s, after a plummeting dollar and surging inflation prompted the central bank to raise interest rates as high as 20 percent.
“If everyone on the planet criticizes the Fed every time they act, you sharply reduce the benefits of Fed policy,” Harris said. “QE2 was severely undercut by the severe criticism it faced, so the Fed would rather not be riding to the rescue again on the rather sore-footed horse that they’re riding right now.”
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