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Unemployment Pressures Fed to Buy Bonds, Economists Say

Unemployment Puts Pressure on Fed to Buy Bonds
Job seekers fill out applications and other related paperwork at a job fair in Chicago. Photographer: Tim Boyle/Bloomberg

Pressure is increasing on the Federal Reserve to stimulate the economy through a third round of bond purchases after a U.S. government report showed employers hiring at the slowest pace in nine months, economists said.

U.S. businesses expanded payrolls by 18,000 in June and the unemployment rate rose to 9.2 percent, marking the third consecutive monthly increase. The rise in payrolls fell below the most pessimistic forecast in a Bloomberg News survey of economists, which called for a 105,000 gain.

Should unemployment climb and growth slow in coming months, then “another round of bond buying would be a distinct possibility,” said Sung Won Sohn, an economics professor at California State University-Channel Islands. “If the unemployment rate were to rise to 10 percent, a psychologically important figure, there would be a hue and cry for the Fed to do more, especially from politicians,” he said.

The Fed started a program in November to buy $600 billion in Treasury securities, known as quantitative easing, when the unemployment rate was 9.8 percent. The rate hit a post-recession peak of 10.1 percent in October 2009. It was the highest rate in 26 years.

Fed Chairman Ben S. Bernanke said at a June 22 press conference that “frustratingly slow” economic growth is due to transitory factors such as high energy prices and that the recovery should pick up in the second half. Policy makers released forecasts that day indicating they estimate unemployment will fall to 8.6 percent to 8.9 percent by December.

Weak Report

The weak employment report “raises doubts that the second half of the year will see much improvement in the overall economy,” said Doug Duncan, chief economist at Fannie Mae. Continued weak hiring will “push out into the future the time that we can expect the housing market to heal,” he said.

The asset purchases were geared toward spurring economic growth, increasing employment, boosting stock prices and prompting consumer spending through reduced borrowing costs.

The odds of a third round of quantitative easing, or “QE3,” are one in five, said Allen Sinai, chief global economist for Decision Economics Inc. The Fed through additional bond purchases would seek to avert a “vicious cycle,” in which a slowdown in hiring prompts consumers to spend less, slowing the recovery, he said.

Record Low

The central bank will probably hold the benchmark interest rate at a record low of between zero to 0.25 percent through at least the first half of 2012, Sinai said. “The Fed will be on hold as far as the eye can see.”

Bernanke on June 22 left the door open to a new round of bond-buying should the economy weaken. He said the Fed has other tools to stimulate growth, including the option to commit to low interest rates for a longer period of time in its post-meeting policy statement. The central bank also could cut the interest rate it pays banks on excess reserves held at the central bank, he said.

The economy was in worse shape when Bernanke signaled last August that the central bank would pursue a second round of asset purchases.

Employers were cutting jobs -- 59,000 of them in August 2010 alone -- and unemployment rose that month to 9.6 percent. Also, Bernanke was concerned about the risk of deflation, or a broad-based drop in prices, wages and asset values such as homes and stocks.

Fed Mandate

“As of last August, we were essentially missing significantly on both sides of our mandate,” Bernanke said on June 22. “Inflation was too low and falling, and unemployment looked like it might be even beginning to rise again. In that case, the case for monetary action was pretty clear,” he said.

Growth will quicken during the second half of this year to a 2.5 percent to 3 percent rate compared with estimated growth of between 1.5 percent and 2 percent during the first half of this year, Sinai said.

Still, the U.S. economy needs to grow at a 5 percent rate for a full year in order for unemployment to fall by around 1 percentage point, according to economists including Bernanke.

“We do still expect GDP growth and consequently employment growth to rebound a little in the second half of the year,” said Paul Ashworth, chief U.S. economist at Capital Economics, in Toronto. “But judging by this report, that rebound hasn’t started yet,”

Inhibited Growth

Bernanke, at the June 22 news conference, said that some forces that inhibited economic growth in the first half of the year will fade, including a shortage of parts to U.S. factories following the Japan earthquake. He predicted the economy will rebound in the second half of this year, while adding that declining home prices, high unemployment and weaknesses in the financial system may weigh on the growth in the longer term.

If the economy seems close to stalling and the unemployment rate keeps rising, “then the Fed would jump in, but the hurdle is high for the Fed to engage in another large-scale asset purchase program,” said former Fed Governor Lyle Gramley.

The Fed last month also lowered its forecast for economic growth this year and raised its forecast for unemployment. Growth won’t exceed 2.9 percent this year, compared with a 3.3 percent rate at the top end of its forecast in April.

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