Fed’s Efforts May Move Markets More Than Economy

U.S. Federal Reserve Chairman Ben S. Bernanke
Chairman Ben S. Bernanke told Congress last month that the Fed was “prepared to take further policy actions as needed” to support an economy hobbled by 9.5 percent unemployment. Photographer: Joshua Roberts/Bloomberg

Federal Reserve policy makers meeting today may find the market reaction to any announcement of steps to spur growth will be bigger than the impact on the economy.

Options outlined last month by Fed Chairman Ben S. Bernanke include providing more information about the Fed’s pledge to maintain record-low interest rates, reducing the rate it pays on banks’ reserve deposits and sustaining or expanding the size of the balance sheet.

“If they’re small scale, the direct effects are relatively small,” said Marvin Goodfriend, a former research director at the Richmond Fed. “But to the extent that they signal the Fed’s concerns and what direction they are, and the Fed’s willingness to take actions given the signal of their concerns, they could have big effects.”

Investors would see new Fed efforts as foreshadowing more dramatic steps to come, including large-scale asset purchases, said Goodfriend, a professor at Carnegie Mellon University’s Tepper School of Business in Pittsburgh. Weaker job gains at U.S. companies since April and a slowdown in growth last quarter are among signs the recovery is stalling, increasing pressure for more Fed easing.

Bernanke said July 21 that the central bank wasn’t ready to take any action in the “near term.” At the same time, his assessment that the “economic outlook remains unusually uncertain,” along with recent weakness in data on housing and manufacturing, have fueled speculation by some economists the Fed will take steps as soon as today.

Meeting Begins

The Federal Open Market Committee, which began its meeting at 8 a.m. today, plans to release a statement at about 2:15 p.m. in Washington.

Policy makers probably aren’t ready to indicate they’ve “hit the panic button” by taking steps today, said Mitch Stapley, chief fixed-income officer for Fifth Third Asset Management.

Should it decide to do so, “risk-based assets probably fly,” including stocks, corporate bonds and high-yield securities, while bond yields may decline, he said.

“That would be the first salvo” by the central bank toward bigger actions, said Stapley, who helps oversee about $18 billion in Grand Rapids, Michigan.

Central bankers won’t cut their outlooks enough to warrant an immediate shift in policy, says former Fed Governor Laurence Meyer, vice chairman of consultant Macroeconomic Advisers. The Fed’s statement will probably be changed to “show sensitivity to the heightened sense of risk,” Michael Feroli, JPMorgan Chase & Co.’s chief U.S. economist, said in an Aug. 6 research note.


“The Fed may look for market-friendly ways to adjust the language of its policy statement, but we think it is unlikely to make any structural changes to its operations at this meeting,” said Lou Crandall, chief economist at Jersey City, New Jersey-based Wrightson ICAP LLC, a unit of ICAP Plc.

At their last meeting in June, Fed officials left their target range for the benchmark rate at zero to 0.25 percent, where it’s been since December 2008. They also reiterated their commitment since March 2009 to keep borrowing costs “exceptionally low” for an “extended period.”

Some economists said the odds rose that the Fed will make a move today after a report Aug. 6 showed private employers added 71,000 jobs in July, below the 90,000 median estimate in a Bloomberg News survey.

Including government workers, the U.S. lost 131,000 jobs in July, compared with the median economist estimate of a 65,000 decline. The unemployment rate was unchanged at 9.5 percent.

Two-Year Notes

Two-year Treasury yields rose 0.02 percentage point to 0.545 percent at 8:11 a.m. in New York today after touching a record low of 0.4977 percent on Aug. 6, while 10-year rates fell two basis points to 2.81 percent. Inflation is running below the Fed’s long-range goal of 1.7 percent to 2 percent.

Policy makers are “going to want to release a statement that signals their concern about the downside risks to the outlook,” said Julia Coronado, senior U.S. economist at BNP Paribas in New York and a former Fed staffer in Washington.

“They may decide to describe the economic outlook as ‘unusually uncertain,’” echoing Bernanke’s congressional testimony last month, she said.

The central bank will probably decide today to reinvest proceeds from their mortgage bond holdings into new securities, a move that could lower home-loan rates enough to increase refinancing and boost the economy, said Douglas Lee, a former congressional economist.

‘Big Splash’

“Anything the Fed does right now would make a big splash, even a small thing,” said Lee, who runs Economics from Washington, a consulting firm in Potomac, Maryland.

Fed officials may not want to see a big market reaction or to fuel expectations of more easing, said Tom Gallagher, head of policy research at International Strategy & Investment Group Inc. in Washington.

Should the Fed announce a plan to reinvest payments from mortgage-backed securities, “markets would read that as an affirmation that they’re right in thinking that the Fed is warming to more” monetary stimulus, Gallagher said.

Among the other steps the central bank may announce today, reducing the 0.25 percent rate paid on banks’ reserve deposits would have a “very marginal” impact, Goodfriend said.

Committing to keep borrowing costs low for a set period also may not prove very helpful, said Angelo Melino, a former special adviser to the Bank of Canada and a University of Toronto economics professor. The Bank of Canada in April 2009 provided such a timeframe, reduced borrowing costs, he said.

“In the states it’s not clear to me that’s going to be as helpful,” Melino said, citing low yields on two-year Treasuries and the Fed’s difficulty ensuring the impact of its lower interest rates spread throughout the economy. “The transmission mechanism in the U.S. still isn’t working that well,” he said.

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