Bernanke 2011 Outlook May Swing Fed Decision on Bond Purchases
Federal Reserve Chairman Ben S. Bernanke’s growth forecast for 2011 may carry more influence than usual as Fed officials debate whether to resume large-scale purchases of Treasury notes to boost the economy.
The former Princeton University professor rarely dictates decisions to the Federal Open Market Committee because he considers groups better at reaching conclusions than individuals, said Roberto Perli, who until July was a member of the Fed Board’s Monetary Affairs Division staff. The Fed panel’s Sept. 21 meeting may be different.
“Chairman Bernanke will be the leading force in this decision,” said Dean Maki, chief U.S. economist at Barclays Capital Inc. and a former Fed Board of Governors economist. “When views are divided, his influence is magnified.”
Fed presidents Jeffrey Lacker of Richmond, Richard Fisher of Dallas and Thomas Hoenig of Kansas City have all voiced opposition to more Fed action. Hoenig, currently a voting member of the FOMC, has dissented at every meeting this year. Forecasts also vary. San Francisco Fed economists predict growth of 3.5 to 4 percent next year, while the Minneapolis Fed forecasts growth of 2.8 percent.
“It comes down to what Bernanke wants to do and how convinced he is that the economy is weakening and unlikely to pick up going forward,” said Perli, director of policy research at International Strategy & Investment Group Inc. in Washington.
Hobbled by an unemployment rate that has stayed above 9 percent all year, the U.S. economy grew at a 1.6 percent annual rate in the second quarter. Bernanke’s sense of whether the soft patch is temporary or entrenched will form the base of the committee’s decision to wait for more data or forge ahead with more Treasury purchases, economists said.
“The debate will be over whether they should increase the balance sheet,” now near the record high of $2.35 trillion in total assets, Perli said.
Goldman Sachs Group Inc. economist Sven Jari Stehn says the Fed could buy “at least” $1 trillion in Treasury notes, and “sizeable purchases of Treasury securities” will begin later this year or early next year.
The Fed chairman told central bankers gathered in Jackson Hole, Wyoming, last month that “preconditions for a pickup in growth in 2011” appear to be in place. At the same time, he warned of the uncertainty of forecasts and said the “prospect of high unemployment for a long period of time remains a central concern of policy.”
“The committee is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly,” he said.
Some U.S. central bankers said the Fed has already done enough, and should have a high bar for doing more. Policy makers have kept their benchmark interest rate at almost zero since December 2008 and bought about $1.7 trillion in Treasury, agency and mortgage-backed securities to battle the worst recession since the 1930s.
After large-scale securities purchases ended in March, the Fed’s portfolio started to shrink as some mortgages were paid. At their last meeting on Aug. 10, policy makers decided to reinvest proceeds from maturing mortgage-backed and housing agency securities back into long-term Treasuries to keep the portfolio stable at around $2.05 trillion and prevent money from draining out of the banking system.
Some Fed officials were concerned that a decision to keep securities holdings unchanged would inadvertently signal an intention to resume large-scale asset purchases, minutes of the Aug. 10 meeting showed. A few policy makers said the economic effects of the decision “likely would be quite small.”
“There are very real impediments to growing more rapidly than we are growing right now,” the Richmond Fed’s Lacker said in a Sept. 10 interview, citing uncertainty on taxes and regulatory policy and an overhang of unsold homes. “There’s not that much that monetary policy can do to address those impediments without risking inflation pressures down the road.”
“I think we are far away from further stimulus being warranted,” Lacker added.
Even if central bankers don’t opt for additional purchases next week, they are likely to further refine plans to do so if needed. James Bullard, president of the Federal Reserve Bank of St. Louis, said he wants any additional expansion of the balance sheet to be done in small increments rather than a “shock-and- awe” policy of announcing $1 trillion in purchases.
“There is a debate” within the Fed on which approach works better, said Antulio Bomfim, a managing director at Macroeconomic Advisers LLC in Washington and former member of the Fed Board staff.
‘Gun on Table’
Announcing $1 trillion in purchases is like “putting your gun on the table and making it clear that you mean it,” he said. That may cause the FOMC to get locked into a policy that it may want to end sooner. An incremental approach, by contrast, risks making the Fed look powerless.
A middle ground, Bomfim said, would be to announce an “up to” target of $500 billion or $1 trillion and make it conditional on the economic developments. The central bank can lower the yield on the 10-year Treasury note by about 3 basis points for each $100 billion it spends, Macroeconomic Advisers estimates. A basis point is 0.01 percentage point.
“We think this is the way to bridge this,” he said. “You announce a bigger number, but you say we could buy more or less depending on how the outlook evolves.”
Bond investors are growing more convinced that the Fed will push Treasury yields down to the levels of the 1950s with another round of asset purchases.
Demand for options on Treasury futures that protect against falling rates is outstripping that for swaptions, options on interest rate swaps, signaling an increased desire to hedge against falling Treasury yields.
“Investors, including non-fixed income, are looking to buy protection against the 10-year Treasury note yield from falling further,” said Piyush Goyal, fixed-income strategist at Barclays Capital in New York. “These investors are bidding up the price of options on Treasury futures to hedge” against rates falling further.
Yields on U.S. 10-year notes fell 6 basis points, or 0.06 percentage point, to 2.74 percent in late New York trading yesterday.
Just continuing at the current rate of growth would constitute a deterioration of the outlook, some economists say. Views vary on the Federal Open Market Committee on whether that will be the case.
John Williams, director of research at the San Francisco Fed, forecasts an expansion next year of 3.5 percent to 4 percent. Minneapolis Fed President Narayana Kocherlakota predicts the economy will expand at a 2.8 percent rate next year. The median forecast in a Bloomberg News survey of 59 economists conducted this month is for growth of 2.5 percent.
Economists such as Ethan Harris of Bank of America Merrill Lynch, the Conference Board’s Ken Goldstein, and Jan Hatzius of Goldman Sachs Group Inc. all predict the economy will expand at a less than 2 percent rate in 2011.
Failing to act in response to a sluggish growth rate would be surprising, economists said, because Bernanke said at Jackson Hole that the Fed is prepared to do more if the “outlook were to deteriorate significantly.”
“If their 2011 forecast is for below 3 percent growth, then they would interpret their mandate as needing to do more,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co., who predicts the economy will grow 2.4 percent next year.