Fed’s Little-Noticed Escape Clause Allows for U.S. Growth
Federal Reserve Chairman Ben S. Bernanke is giving himself an escape clause from his latest stimulus steps in case the economy finally gains momentum.
He’s made his third round of quantitative easing open-ended -- meaning the program doesn’t have a set time frame -- and signaled he may adjust its pace if needed. In December, the policy-setting Federal Open Market Committee added outright Treasury purchases to its mortgage-bond buying, saying it would acquire U.S. government debt “initially” at a pace of $45 billion a month on top of $40 billion in home-loan debt.
The strategy gives officials maneuvering room to slow purchases if gross domestic product expands at a more robust pace than forecast, said Dean Maki, chief U.S. economist at Barclays Plc. Fed officials in December projected growth in a range of 2 percent to 3.2 percent in 2013, already more optimistic than Wall Street’s median estimate of 2.2 percent, based on 57 analysts in a Bloomberg survey conducted Jan. 4 to Jan. 9.
The Fed “doesn’t want to box itself in,” Maki, a former Fed board economist, said in a telephone interview from his New York office. “You could have a situation where financial markets improve and that leads to better growth. They want to not be committed to keep policy on hold, even if that stronger cycle were to get going.”
The approach also would allow the Fed more easily to pull back on its stimulus if financial stability were threatened by forces such as market bubbles or if inflation picked up after years of being tame. Conversely, if the outlook deteriorated, the central bank could prolong its bond buying.
“The extra flexibility will work both ways: They can stop sooner or keep going longer” than if they had set out parameters from the start, said Dana Saporta, U.S. economist at Credit Suisse Group AG in New York. She predicts the Fed will add to its bond portfolio throughout 2013, after reducing the pace midyear.
Central bankers at their December meeting discussed potentially curtailing or ending their asset purchases this year, surprising analysts and traders when the minutes were released on Jan. 3. The Standard & Poor’s 500 Index fell 0.2 percent and yields on the benchmark 10-year Treasury note rose 0.07 percentage point that day.
“Several” FOMC members said it would “probably be appropriate to slow or stop purchases well before the end of 2013,” because of concern about the Fed’s swelling balance sheet, according to the minutes of the Dec. 11-12 gathering. A “few” were willing to let the program run to the end of the year, while “a few others” didn’t give a time frame.
John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina, said he was among those who weren’t anticipating the possibility that Fed stimulus would be pared back so soon.
“I had not gotten any inkling that there was a sufficient number of Fed governors and regional Fed presidents who would have considered ending the easing by the end of this year,” Silvia said.
The minutes may have surprised Wall Street analysts in part because private forecasters are more bearish than the Fed, Silvia said. He predicts growth of 2 percent in 2013, at the bottom of the Fed’s range, with the central bank buying bonds at its current pace of $85 billion a month throughout the year.
Policy makers at their last meeting saw the economy continuing to expand at a “moderate pace” as concerns about the so-called fiscal cliff restrained growth. While a deal was struck in time to avert some tax increases slated to take effect Jan. 1, automatic spending cuts were forestalled by two months and their fate remains unresolved as the U.S. again nears its statutory borrowing limit.
“Some” Fed officials “noted that an early and constructive resolution to fiscal-policy negotiations had the potential to release pent-up demand,” the minutes said. “A number of participants suggested that the business sector was well positioned to expand spending and hiring quickly upon a positive resolution of the fiscal-cliff negotiations.”
While the Fed may have positioned itself to more easily halt its stimulus if the economy picks up, its base-case scenario may prove too rosy, along with the even more optimistic outlook. A year ago, policy makers forecast expansion in a range of 2.1 percent to 3 percent for 2012. Analysts in the Bloomberg survey this month estimate the economy grew 1.9 percent.
Wall Street analysts have been “a little burned” by “forecasts that have been disappointed in terms of what fiscal or monetary policy can achieve,” Silvia said. “The Fed is still being somewhat optimistic that ‘Hey, you know, we still can move ahead, we still have a lot of power here.’”
The central bank is running out of new ways to boost growth after keeping its benchmark interest rate near zero since December 2008 and expanding its balance sheet to a record of almost $3 trillion through its asset-purchase programs.
Still, Bernanke’s open-ended approach to quantitative easing would help him respond quickly if the inflation his critics have warned he’d cause ever materializes, Saporta said.
The second round -- $600 billion of purchases announced in November 2010 -- sparked the harshest political backlash against the central bank in three decades, with criticism leveled by Republicans, from House Speaker John Boehner of Ohio to former Representative Ron Paul of Texas, that the program risked a rapid acceleration in prices.
More than two years later, this has yet to happen. Inflation as measured by the personal consumption expenditures price index rose 1.4 percent in November from a year earlier. The Fed aims for inflation of 2 percent.
Central bankers in December also adopted a more flexible approach to their interest-rate outlook, saying borrowing costs will stay low “at least as long” as unemployment remains above 6.5 percent and if the Fed predicts inflation of no more than 2.5 percent one or two years in the future. That language replaced an earlier link between the rate outlook and calendar dates. Unemployment was 7.8 percent in December and November.
Saporta said she doesn’t see the 2.5 percent inflation level “as a binding threshold for the foreseeable future.” Debt traders anticipate prices will accelerate at a 2.1 percent rate during the next five years as measured by the break-even rate for five-year Treasury Inflation Protected Securities, a yield differential between the inflation-linked debt and Treasuries that measures projections for consumer prices over the life of the securities.
Preserving the option to alter the pace of bond buying or stop it altogether will allow the Fed to tailor its policies as the outlook changes, Silvia said.
“It was perhaps simplistic for us to assume they’re going to buy $45 billion all year,” Silvia said, referring to the pace of Treasury buying. “The Fed’s saying their strategy is a little more nuanced.”
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