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Bernanke Critics Can’t Fight Bonds Showing No Inflation

Fed Chairman Ben S. Bernanke
U.S. Federal Reserve Chairman Ben S. Bernanke. Photographer: Chris Rank/Bloomberg

As Ben S. Bernanke considers whether to worry about inflation before adding to his record monetary stimulus today, he has the bond market on his side.

Debt traders are anticipating prices will accelerate at the Federal Reserve’s target rate of about 2 percent during the next five years. The break-even rate for five-year Treasury Inflation Protected Securities -- a yield differential between the inflation-linked debt and Treasuries -- was 2.07 percentage points on Dec. 11. That’s a measure of the outlook for consumer prices over the life of the securities.

The bond market shows that, two years after the Fed’s second round of asset purchases sparked criticism from Republicans predicting a surge in prices, there’s no incipient anxiety of such risk. That confidence in Bernanke’s ability to keep inflation in check bolsters policy makers’ case for expanding their third round of so-called quantitative easing at the two-day meeting that began yesterday.

“The market seems to be convinced the Fed is going to get it just right,” said Dean Maki, chief U.S. economist at Barclays Plc in New York. It’s “not providing a lot of resistance to the Fed’s easing.”

Maki predicts the central bank will continue buying bonds at its current monthly pace of $85 billion after the expiration of Operation Twist by year-end. Under the program, announced in September 2011, the Fed has been swapping $45 billion of short-term Treasuries for longer-term debt.

No Limit

Since September, the Fed also has been buying $40 billion of mortgage-debt securities a month in an effort to boost growth and create jobs. The central bank didn’t put a limit on the size or duration of the purchases.

Federal Reserve Bank of New York President William C. Dudley, who is also vice chairman of the policy-setting Federal Open Market Committee, said he’s “assessing the employment and inflation outlook” in deciding whether the central bank should continue buying Treasuries next year.

Joblessness is “unacceptably high,” while inflation expectations are “fully consistent with our longer-run inflation objective,” Dudley said during a Nov. 29 speech in New York.

The unemployment rate was 7.7 percent in November. Inflation as measured by the personal consumption expenditures price index rose 1.7 percent in October from a year earlier.

Minneapolis Fed President Narayana Kocherlakota, Chicago Fed President Charles Evans, Eric Rosengren of Boston and John Williams of San Francisco all have voiced support for additional stimulus since the FOMC last met Oct. 23-24.

Support Decisions

“Given the effectiveness of this policy and the relatively high unemployment rate and inflation that is running below our 2 percent target, I fully support the policy decisions to provide stimulus through asset purchases,” Rosengren said in a Dec. 3 speech in New York.

Not all Fed officials are endorsing additional bond buying. Philadelphia Fed President Charles Plosser said Dec. 1 it may be “very difficult for us to reverse course,” and “we also have to worry about the future and the consequences of our policies.” James Bullard of St. Louis said Dec. 3 that replacing Operation Twist’s swap of Treasuries with outright purchases of the same amount would risk higher inflation.

So far, the data haven’t born out warnings that the Fed’s quantitative easing may lead to a rapid acceleration in prices. QE2, announced in November 2010, unleashed the harshest political backlash against the U.S. central bank in three decades, with criticism leveled by Republicans from House Speaker John Boehner of Ohio to Representative Ron Paul of Texas.

Worst Fears

“Some of the worst fears of quantitative easing, of a pickup in inflation or a severe devaluation in the dollar, did not come to pass with QE1 or QE2, so while you still hear critics,” they “seem to be more subdued this time around,” said Dana Saporta, a U.S. economist at Credit Suisse Group AG in New York.

Some Republicans have sought a change in the Federal Reserve Act that would restrict the Fed’s focus solely to its goal of price stability. Bob Corker, a Tennessee Republican on the Senate Banking Committee with Fed oversight authority, said in a Sept. 25 interview he would “continue to champion” a single mandate.

Saporta said she doesn’t “see an inflation problem in the near term at all” and doesn’t think QE3 poses such a risk. Inflation expectations have fallen from 2.37 percent on Sept. 14, the day after QE3 was announced, as measured by the five-year break-even rate. Yesterday’s 2.07 percentage points compare with 2.09 points on Sept. 12.

Not Worried

Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut, said he’s no longer worried about inflation after previously criticizing the Fed’s policies. Price changes are “wrapped up” in the growth outlook, said Stanley, who added he’s no longer “optimistic” about the economic expansion.

The U.S. “feels like it’s stuck in this everlasting 2 percent-type range, so I just don’t see much of a move in inflation,” Stanley said. “I might have been one of the last holdouts, and I have given up the ghost.”

The economy will grow 2.2 percent this year and 2 percent in 2013, according to the median estimate of 74 economists surveyed by Bloomberg News from Nov. 9 to Nov. 14.

The Fed’s expanded balance sheet still may lead to inflation in the future, Stanley said. The central bank’s assets have ballooned to about $2.9 trillion from about $894 billion at the end of 2007.

`Raw Material'

“QE is obviously still providing the raw material for price increases down the road, but, until the economy catches fire,” inflation won’t move much, he said.

The central bank doesn’t plan to raise its benchmark interest rate until at least mid-2015, and policy will remain accommodative “for a considerable time,” even after the economy strengthens, the Fed said after its September and October policy meetings.

“Inflation is not a concern,” Saporta said. “That gives the Fed leeway to continue with asset purchases.”

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