Federal Reserve officials are staying open to further monetary easing this year as they monitor risks that threaten to move the economy further away from their mandate for stable prices and full employment.
Atlanta Fed President Dennis Lockhart told reporters Jan. 9 that he hadn’t closed out “the option” for more stimulus, while New York Fed President William C. Dudley said in a Jan. 6 speech that it’s “appropriate” to evaluate whether the Fed could do more to boost growth. Both are voting members of the Federal Open Market Committee.
Among the possible triggers for action, according to Ethan Harris, co-head of global economic research at Bank of America Merrill Lynch in New York: a slump in U.S. gross domestic product caused by a European recession, a more rapid slide in U.S. inflation than anticipated, and deteriorating U.S. payroll growth.
“The labor market has a special role,” said Harris, who doesn’t expect the Fed to move at next week’s meeting. “They are looking for a real healing process there” because job growth “helps drive the housing market, it helps drive the banking system with its bad debt issues, and, obviously, it helps the consumer.”
Fed Chairman Ben S. Bernanke and his fellow policy makers will publish their latest economic forecasts after their meeting on Jan. 24-25. For the first time, they will reveal their own predictions for the benchmark federal funds rate, as well as “qualitative information” regarding their expectations for the $2.9 trillion Fed balance sheet that could provide hints on further easing.
Wholesale prices in the U.S. unexpectedly dropped in December, the Labor Department reported today. The producer price index fell 0.1 percent. The core measure, excluding food and energy, rose 0.3 percent as the cost of light trucks climbed. Manufacturing rose 0.9 percent last month, the biggest gain since December 2010, according to the Fed’s report on industrial production.
Bernanke will hold a press conference after the meeting and may indicate that a third round of large-scale asset purchases, also known as quantitative easing, is still on the table even as recent reports point to an acceleration of the two-year expansion.
“It doesn’t require a whole lot of disappointment on either the growth or inflation side to get quantitative easing going again,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. “If you get enough deflationary fears, and inflation expectations move down, I don’t think they would see a lot of costs” to purchasing more bonds.
Minutes of the December FOMC meeting said “a number” of members indicated economic conditions “could well warrant additional policy accommodation.” Feroli said JPMorgan isn’t expecting more bond purchases this year, though “it’s a close call.”
“Under their baseline outlook, unemployment is still too high, inflation is moderating and housing still needs special attention,” said Michael Gapen, a senior economist at Barclays Capital in New York and former staff member of the Fed Board’s Division of Monetary Affairs. “After they roll out their communications strategy this month, you could have a vocal component of the FOMC making the case for more bond-buying to support the housing market.”
Won’t Ease Further
Barclays forecasts that the Fed won’t ease further if U.S. economic growth stays at a 2 percent annual rate or more because inflation will probably remain firm.
A government report this month showed improvement in the job market. Payrolls rose by 200,000 in December, double the previous month’s gain, while hours worked and earnings climbed. The unemployment rate unexpectedly fell to 8.5 percent from 8.7 percent.
Still, economists surveyed by Bloomberg News in January say unemployment won’t fall below 8.4 percent this year, while inflation could stay at a 1.7 percent annual rate in the fourth quarter, according to their median forecasts. The personal consumption expenditures price index, minus food and energy, has slowed to a 1 percent three-month annualized rate from 2.1 percent in September.
Harris and Paul Edelstein, director of financial economics at IHS Global in Lexington, Massachusetts, said the Fed in any asset purchases will probably focus on mortgage-backed securities to support housing markets.
“Our baseline case is that the recovery endures, but it is going to be a weak one,” said Edelstein, a former New York Fed staff economist. “We think the Fed will most likely pull the trigger on quantitative easing three.”
Harris said that additional easing will probably come after June, when the Fed is scheduled to complete “Operation Twist,” a program announced last September that involves shifting its portfolio into longer-dated assets.
“The next quantitative easing is going to have to involve significant mortgage buying,” said Harris, who estimates that the U.S. central bank could purchase $800 billion in bonds later this year, including about $500 billion in housing-related debt. “The Fed isn’t trying to change the borrowing costs of the U.S. government. They are trying to change the borrowing costs of the private sector.”
Policy makers dissented in half the FOMC’s meetings last year. That’s partly a reflection of the disagreements policy makers have about the effectiveness of unconventional policy and how quickly they can exit a balance sheet that has swollen to nearly $3 trillion.
Federal Reserve Bank of Richmond President Jeffrey Lacker told reporters last week that he didn’t see “a compelling case” for more stimulus.
“The fear is that because they have never done this, it increases the risk of a policy mistake,” said Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC in Washington. For that reason, Bomfim predicts the FOMC will try to reduce longer-term rates by revealing more about policy making rather than by purchasing more bonds.
“If there is one thing that really strikes fear in the heart of any policy maker, it is the notion of disrupting stable long-term inflation expectations,” Bomfim said.
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