Pacific Investment Management Co.’s Mohamed El-Erian said the Federal Reserve will expand its bond purchases to include Treasuries by early next year.
The central bank in its December or January Federal Open Market Committee meeting will announce plans to add Treasury purchases to the $40 billion in mortgage-backed securities it is now buying in its third round of quantitative easing, known as QE3, El-Erian, chief executive officer of the world’s biggest manager of bond funds, said in an interview on Bloomberg Television’s “In the Loop” with Betty Liu. The Fed will also take additional steps to improve transparency in communication of the path of monetary policy, he said.
The Fed may continue in January with the Treasury purchases that are now part of the central bank’s maturity extension program, known as Operation Twist, discontinue the sales, or let the program end and add Treasuries to its QE3 purchases, according to El-Erian. The Fed is buying $45 billion in long- term debt each month as part of Twist. The program is slated to end on Dec. 31.
“Expect QE to be expanded,” he said. Also “look for them to try and take a step forward on quantitative thresholds,” said El-Erian, referring to the Fed’s likely move away from targeting short-term rates to a calendar date and to measures such as employment or inflation.
Fed policy makers “generally favored the use of economic variables” to provide guidance on the when they are likely to approve their first interest-rate increase since 2008, according to minutes of their Oct. 23-24 meeting released yesterday. Such measures might replace or supplement a calendar date, currently set at mid-2015.
A number of officials also said the Fed may need to expand its monthly purchases of bonds next year after the expiration of Operation Twist. The discussion indicates that Fed officials judge the economy still needs record stimulus to reduce an unemployment rate stuck near 8 percent.
“What they are trying to do, as they have very few degrees of freedom, is to try and use communication to change behavior,” El-Erian said. “And they are evolving it further and further into unknown territory.”
Fed officials said the potential U.S. fiscal contraction known as the fiscal cliff poses another risk to the economic expansion, according to the minutes. Participants said businesses have reported “delaying or cutting back on hiring and capital spending” because of the uncertainty.
President Barack Obama’s re-election this month set up a showdown over the federal budget with the Republican-controlled House of Representatives. If Congress doesn’t act by the end of the year, $607 billion in automatic spending cuts and tax increases take effect starting in January.
“There is a tail risk that we may not get an agreement and that would push us into recession and the market is nervous about that,” said El-Erian, who noted that Pimco give about 60 percent odds that some type of agreement is made before year- end. “What we are likely to get is what we call a mini bargain, which is a partial compromise simply to kick the can down the road. Then in a few month’s time all of us are going to be talking again about fiscal reform and asking the question can this mini bargain be a down payment for something bigger.”
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