Fed Faces Risk of Fourth Summer Slump While Pushing QEJoshua Zumbrun
This time, Federal Reserve policy makers are prepared for the summertime slump.
During the past three years, the Fed planned to cut accommodation early in the year only to boost it after economic growth lagged behind its forecasts. Determined not to repeat the error, the Fed will probably push on with $85 billion in monthly bond purchases through the summer, said Drew Matus, a former Federal Reserve Bank of New York economist.
“The fact they’ve been fooled multiple times by slumps in the U.S. economy means they’re going to be a little gun-shy on the exit strategy,” said Matus, deputy chief U.S. economist at UBS Securities LLC in Stamford, Connecticut.
Last week’s Labor Department report showing the economy generated just 88,000 jobs in March, the fewest in nine months, confirmed the concerns of William C. Dudley, president of the New York Fed, that the job market was weaker than it appeared. The April 5 report followed six months of payroll growth averaging 197,000.
“The recent improvement in payroll employment growth, which gets much of the attention, is out-sized relative to the growth rate of economic activity that supports it,” Dudley, vice chairman of the policy setting Federal Open Market Committee, said in a March 25 speech in New York. “We have seen this movie before. When this happened in 2011 and 2012, employment growth subsequently slowed.”
The March jobs report will probably bolster the argument of FOMC voting members Dudley, Chicago Fed President Charles Evans and Boston’s Eric Rosengren that the central bank should keep adding to record stimulus through the end of the year.
“I’m going to have a lot more confidence if I begin to see indications that growth is well above trend and it’s going to be sustainable,” Evans said to reporters at the Chicago Fed on March 27. “Continued accommodative policy, such as continuing our asset purchase program through this year, is an appropriate response to labor-market scarring,” Rosengren said in a speech on April 5, before the Labor Department released its report.
Treasuries last week soared the most since August on bets a slowing economy will prompt the Fed to maintain bond purchases. Ten-year note yields fell 14 basis points, or 0.14 percentage point, to 1.71 percent, according to Bloomberg Bond Trader prices.
The Standard & Poor’s 500 Index fell less than 0.1 percent to 1,552.30 at 10:51 a.m. in New York as investors awaited Alcoa Inc.’s financial release to mark the beginning of the earnings season. The S&P 500 fell 1 percent last week, for the biggest decline so far this year, as payrolls data missed economists’ estimates.
“There’s a very strong message to the Fed here, which is that it’s too early to even think about exiting from easy policy,” said Ethan Harris, co-head of global economics research at Bank of America Corp. in New York. “This report suggests that they’re missing on both of their mandates: Inflation is too low and the labor market is too weak.”
The concern this year is that a promising start will be derailed by across-the-board federal budget cuts known as sequestration. In years past, shocks from Europe, Japan and the Middle East roiled U.S. financial markets and the economy.
In January 2010, policy makers forecast economic growth of 2.8 percent to 3.5 percent for the year, and in March they allowed the Fed’s $1.7 trillion first round of large-scale asset purchases to end.
Then the debt crisis in Greece hammered U.S. stocks, with the Standard & Poor’s 500 sliding 16 percent from late April through the beginning of July. Concerned about the risk of Japanese-style deflation, the Fed started a second, $600 billion round of quantitative easing. The economy ended up growing 2.4 percent in the fourth quarter of 2010 over the same period of the previous year.
By the start of 2011, optimism had returned, with the S&P 500 gaining 2.2 percent in January. At the FOMC’s meeting that month, policy makers forecast growth of as much as 3.9 percent. In June 2011, central bankers let their asset purchases end as scheduled.
Yet repeated shocks jolted the economy. Political upheaval in the Middle East sent oil prices soaring. A tsunami and earthquake in Japan disrupted global manufacturing supply chains. And U.S. lawmakers struggled to reach an accord to raise the debt ceiling.
The S&P 500 peaked for the year on April 29 and fell 19 percent by Oct. 3. The Fed responded with a stimulus known as Operation Twist, driving down bond yields by swapping short-term debt for long-term bonds. The economy grew 2 percent.
Last year, Europe’s debt crisis flared again. The S&P 500 fell 4.2 percent from the start of April until June 29. That month, the FOMC extended Operation Twist. In September, it launched QE3. The economy grew 1.7 percent for the year, below policy makers’ 2.2 percent to 2.7 percent forecast.
This year, fiscal policy is again at the heart of the Fed’s concerns.
March marked the start of $1.2 trillion in across-the-board Federal spending cuts to be spread over 10 years. The cuts, which will trim 5 percent of the spending from domestic agencies and 8 percent from the Defense Department this fiscal year, follow income-tax increases for the most affluent Americans and a two-percentage-point increase in the payroll tax.
The “greatest danger” to growth is tighter fiscal policy, Dudley said in a March 27 speech.
“We could very well in the summertime start seeing the effects of the fiscal tax increase and spending cut slow us down again,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and a former Fed economist.
There were signs of economic weakness even before last week’s payrolls report. The Tempe, Arizona-based Institute for Supply Management’s factory index for March fell more than forecast, and its services gauge showed the slowest pace of expansion in seven months.
In contrast to its previous quantitative easing programs, the Fed’s current round of asset purchases is open-ended, with no final date or amount specified in advance. That means policy makers can maintain stimulus until the economy gains a more stable footing.
“It helps that we’ve removed one source of uncertainty which is, how will the Fed react?” said Julia Coronado, chief economist for North America at BNP Paribas in New York. “Instead of asking how bad things need to get for the Fed to do more, it’s how good do they need to be before they stop helping.”