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Fed Seen Starting QE3 While Extending Rate Pledge to 2015

The Federal Reserve is likely to announce a third round of bond purchases tomorrow, according to almost two-thirds of economists in a Bloomberg survey, while also extending the duration of its zero-interest-rate policy into 2015.

Chairman Ben S. Bernanke and his colleagues on the Federal Open Market Committee will once again roll out unconventional policies to bolster economic growth of less than 2 percent in the second quarter and bring down unemployment stuck above 8 percent for 43 straight months, the survey showed.

“The Fed clearly wants to do more,” said Nick Sargen, a former San Francisco Fed economist who oversees $40 billion as chief investment officer at Fort Washington Investment Advisors in Cincinnati. “The economy is looking lackluster, and the Fed has said all along that they feel it’s almost immoral that the unemployment rate is as high as it is.”

Two rounds of bond purchases totaling $2.3 trillion have failed to breathe life into the labor market, which Bernanke said last month is a “grave concern.” That means policy makers will probably announce a new open-ended plan tied to a sustained improvement in the economy rather than specify an amount of purchases and an end-date, according to 32 of the 73 economists in the survey. Twenty-two expect a fixed duration and amount.

The FOMC plans to release a statement tomorrow at about 12:30 p.m. after a two-day meeting. At 2 p.m. the Fed will release policy makers’ forecasts for unemployment, inflation and the expected path of the federal funds rate over the next several years. Bernanke plans to hold a press conference at about 2:15 p.m.

Europe Crisis

The euro strengthened to a four-month high and stocks rose for a second day as a German court allowed ratification of a bailout fund, easing the European credit crisis that the Fed has identified as a threat to the U.S. expansion.

The euro appreciated 0.3 percent to $1.2896 at 10:26 a.m. in New York. The Stoxx Europe 600 Index added 0.3 percent, and the Standard & Poor’s 500 Index increased 0.2 percent.

In the U.K. today, a report showed that jobless claims unexpectedly fell the most in more than two years in August as the economy continued to create jobs in the face of a recession.

Stocks and commodities have rallied on expectations of easing by the Fed. From Aug. 1 through yesterday, the S&P 500 rose 4.3 percent to 1,433.56, near the four-year high reached last week. The S&P GSCI Spot Index that tracks the price of 24 commodities advanced 6.8 percent.

Most economists predict that in a new round of easing the Fed would buy a mix of Treasury notes and mortgage-backed securities.

Mortgage Debt

The central bank would buy $300 billion in Treasuries and $400 billion in mortgage debt, according to the median estimates of economists who expect a fixed sum of purchases.

Economists expecting open-ended asset-buying predict monthly purchases of $30 billion in government debt and $35 billion in housing debt. After a year, the Fed would expand its balance sheet by a total of $780 billion.

Policy makers may forgo new bond purchases at this meeting to solidify a consensus on the issue among themselves or to better prepare the public for the move, said Michael Hanson, senior U.S. economist at Bank of America Corp. in New York.

“One reason for waiting would be if the Fed is thinking of structuring this not as a fixed quantity but as a more open- ended plan, but they don’t have the details together yet and don’t have consensus on how to do that,” said Hanson, a former economist at the Fed board in Washington.

Open-Ended

San Francisco Fed President John Williams, Chicago’s Charles Evans and Boston’s Eric Rosengren have called for open- ended purchases. St. Louis Fed President James Bullard said Aug. 31 he prefers the open-ended approach yet would like to see more data before taking action.

In the first round of bond buying, the Fed in November 2008 began purchasing $1.25 trillion of mortgage-backed securities, $175 billion of agency debt and $300 billion of Treasuries to provide further stimulus after the benchmark rate was cut almost to zero in December 2008.

In the second round, announced in November 2010 and lasting through the following June, the Fed bought $600 billion of Treasuries.

Bernanke said Aug. 31 in a speech in Jackson Hole, Wyoming, that a Fed study found that large-scale asset purchases may have raised the level of economic output by almost 3 percent and boosted private payroll employment by more than 2 million jobs. U.S. gross domestic product expanded 2.4 percent in 2010 after contractions of 0.3 percent in 2008 and 3.1 percent in 2009.

Bernanke didn’t describe the options for future quantitative easing.

Risk of Slump

Some Fed officials have spoken so enthusiastically about new easing that a decision to keep policy unchanged tomorrow could trigger a slump in markets, said Neal Soss, chief economist for Credit Suisse Group AG in New York.

“Disappointing the markets doesn’t seem like a good strategy, but it’s not obvious how much more GDP to expect if they fulfill market expectations for more action,” said Soss, a former New York Fed economist.

Central bankers are also poised to extend until 2015 their forecast that economic conditions will probably warrant holding interest rates near zero through late 2014. Sixty-eight percent of economists surveyed expect an extension at tomorrow’s meeting.

At the July 31-Aug. 1 FOMC meeting, a few participants wanted to replace the calendar date with guidance linked to the economic conditions that would warrant raising rates, according to minutes of the gathering. Fifteen percent of economists said the central bank will probably tie the low-rate policy to the performance of the economy.

To contact the reporter on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net; Jeff Kearns in Washington at jkearns3@bloomberg.net

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

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