Fed Poised to Step Up Stimulus Unless Economy Strengthens

The Federal Reserve moved a step closer to pumping more stimulus into an economy plagued by weakening growth and a jobless rate that has stayed at 8 percent or higher for more than three years.

Central bankers led by Ben S. Bernanke concluded their two- day meeting Wednesday saying they “will provide additional accommodation as needed” to bolster the expansion. The Federal Open Market Committee also said it will “closely monitor” economic data and financial developments, suggesting it is focused on the economy’s near-term performance.

“The default is further easing,” said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut. “Unless things improve significantly, they’re going to move” at their Sept. 12-13 meeting, he said.

The dollar strengthened yesterday and Treasuries slid as the Fed said growth had slowed without taking action. Policy makers had reason to wait: they will see two months of payrolls reports before their next meeting, and the European Central Bank today may announce actions to shore up the region’s bond markets and ease the debt crisis that poses one of the biggest risks to the U.S. recovery.

“The Fed is ready to act if things don’t improve,” said Roberto Perli, managing director of policy research at International Strategy & Investment Group in Washington and a former Fed economist. Policy makers probably want to build a “stronger case” for action, he said. “You need more data to do that.”

Dollar Climbs

The Dollar Index (DXY), a gauge of the currency against six major peers, climbed 0.6 percent to 83.13 as the euro slid 0.6 percent to $1.2225 at 4 p.m. New York time. The Standard & Poor’s 500 Index slipped 0.3 percent to 1,375.32 after gaining 0.4 percent earlier. Ten-year Treasury yields increased five basis points to 1.52 percent.

The Fed left unchanged its statement that economic conditions would likely warrant holding the benchmark Fed funds rate near zero “at least through late 2014.” It also said it would continue swapping $667 billion of short-term debt with longer-term securities to lengthen the average maturity of its holdings, an action intended to lower long-term interest rates known as Operation Twist.

A report yesterday showing manufacturing contracted for a second month in July underscored the Fed’s assessment that “economic activity decelerated somewhat over the first half of this year.”

Growth cooled to a 1.5 percent annual pace in the second quarter from 2 percent in the previous three months as consumers and companies pulled back. Job gains slowed to an average pace of 75,000 from April through June from 226,000 in the prior three months.

Easing Tools

Bernanke said in July 17 congressional testimony that the Fed’s tools for additional easing include more purchases of assets, such as mortgage-backed securities, altering communications on the outlook for interest rates and reducing the interest rate paid on excess reserves that banks keep with the Fed.

The Fed chairman will have a chance to talk more about policy options when he speaks to economists and central bankers at the Kansas City Fed’s conference in Jackson Hole, Wyoming, Aug. 30 to Sept. 1. His speech at the 2010 conference set the stage for a second round of large-scale asset purchases, which the committee started in November that year.

Bernanke will also hold a press conference after the September FOMC meeting, when Fed officials publish updated forecasts for growth, unemployment, inflation and interest rates.

Rate Outlook

The interest-rate outlook would provide greater context for a decision to extend the low-rate guidance into 2015. Forecasts showing several more years of scant improvement in unemployment could justify a decision to expand the balance sheet further.

“Conditions are getting ripe for the Fed to ease,” said Eric Green, head of global foreign exchange and interest-rate research at TD Securities in New York and a former New York Fed economist. “They’ve set the tone that if these conditions deteriorate, we’re ready to move in.”

The FOMC’s statement that it will “closely monitor” data on the economy and markets echoed a phrase that was sometimes used under former Chairman Alan Greenspan before the Fed took action between regularly scheduled meetings, Green said.

“We still have to think the odds are low for inter-meeting ease, they’re just higher than they otherwise would be,” he said. “What would get the Fed to move, I think, is if conditions deteriorate in Europe to the point that stocks begin to get hit hard.”

Full Employment

Unless consumer and business spending improve, the Fed is unlikely to make much progress on its dual mandate for full employment and stable prices, said Ward McCarthy, chief financial economist at Jefferies & Co. Inc. in New York.

“They will be paying attention to the data inter- meeting,” McCarthy said. “Sustained improvement in the labor market is the bar Bernanke has set. We have not seen that, and they are not even forecasting that.”

In June, Fed officials forecast unemployment would average 8 percent to 8.2 percent in the fourth quarter of this year, compared with their long-run goal of 5.2 percent to 6 percent. Unemployment stood at 8.2 percent in June.

Inflation fell to 1.5 percent for the year ending June, below the central bank’s 2 percent target.

The Fed’s policy statement yesterday didn’t hint at what type of tools it might use to provide another round of stimulus.

“The most likely tool is more securities purchases and forward guidance” on how long the benchmark federal funds rate will be kept near zero, said Julia Coronado, chief economist for North America at BNP Paribas in New York. BNP economists expect that guidance to be extended into 2015.

“The bar is very low for further action,” Coronado said.

To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net;

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

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