Fed Seen Pumping Up Assets to $4 Trillion in New Buying
Posted 11 December 2012 - 06:13 PM
The Federal Reserve will amplify record accommodation tomorrow by announcing $45 billion in monthly Treasury buying that will push its balance sheet almost to $4 trillion, according to a Bloomberg survey of economists.
Forty-eight of 49 economists predict the Federal Open Market Committee will purchase Treasuries to bolster an existing program to buy $40 billion in mortgage bonds each month. The panel pledged in October to continue that plan until the labor market improves "substantially."
"It's going to be massive and open-ended in size," said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York and a former New York Fed economist.
Chairman Ben S. Bernanke and his FOMC colleagues will press on with purchases at least through the first quarter of 2014, according to the median estimate in the Dec. 7-10 survey. They are expanding the balance sheet beyond $2.86 trillion in a bid to spur growth and lower an unemployment rate of 7.7 percent.
"They view this stimulus as what's needed to sustain the economy" and reinforce improvements in industries such as autos and housing, said John Silvia, chief economist at Wells Fargo & Co., the biggest U.S. home lender.
The FOMC gathers today for a two-day meeting in Washington and plans to release a statement on policy tomorrow at around 12:30 p.m. That will be followed by forecasts for growth, unemployment and inflation. Bernanke is scheduled to hold a press conference at 2:15 p.m., after release of the forecasts.
The central bank this month is scheduled to end Operation Twist, in which it swaps $45 billion of short-term Treasuries each month for longer-term government debt. That program kept the total size of the balance sheet unchanged, while new Treasury purchases would expand it.
The Fed's latest round of quantitative easing will total $1.1 trillion, with about $620 billion in mortgage-backed securities and $500 billion in Treasuries, according to the median estimate in the survey.
By adding Treasury purchases, policy makers "would continue to lower mortgage rates and create conditions that would be favorable for a continued recovery in the housing market," said Roberto Perli, a managing director at International Strategy & Investment Group Inc. in Washington.
"It would also -- if house prices go up more -- mean more households would be able to refinance their mortgage," said Perli, a former economist for the Fed's Division of Monetary Affairs. "That's just like a tax cut or a pay increase because you have more disposable income in your pocket."
Fed purchases of mortgage bonds have helped revive the housing market by pushing down the rate on a 30-year, fixed-rate mortgage last month to a record 3.31 percent.
New-home sales rose 17 percent in October compared with the prior year, while existing-home sales increased 11 percent. Home prices gained 3 percent from a year earlier in September, according to the S&P/Case-Shiller 20-city home-price index.
"Pent-up demand, rising home prices, low interest rates and improving customer confidence motivated buyers to return to the housing market," Douglas Yearley Jr., chief executive officer of Toll Brothers Inc., the largest U.S. luxury-home builder, said in a Dec. 4 earnings call.
Homebuilder stocks have risen after a six-year slump. The Standard & Poor's Supercomposite Homebuilding Index (S15HOME) of 11 homebuilders has surged 72 percent this year, compared with a 13 percent gain for the broader S&P 500.
Even with the recent improvement, home prices remain 29 percent below their July 2006 peak.
Policy makers "do not want mortgage rates to climb much higher," said John Lonski, chief economist for Moody's Capital Markets Group in New York. "They will do their utmost to keep long-term borrowing costs on the low side."
Bernanke said in a Nov. 20 speech that Fed stimulus shows no sign of fueling consumer-price increases beyond the central bank's 2 percent target. "Inflation over the next few years is likely to remain close to or a little below the committee's objective," he said in New York.
The rebound in housing hasn't shown signs of enlivening the labor market. Payroll growth averaged 153,000 in 2011 and 151,000 so far in 2012. Employment climbed by 146,000 in November, the Labor Department said last week. The jobless rate fell from 7.9 percent the month before as the labor force shrank.
Economists don't predict growth will take off in 2013. Gross domestic product expanded at a 2.7 percent annual pace in the third quarter, according to Commerce Department data. Economists in a separate Bloomberg survey forecast growth of 2 percent in 2013.
Also weighing on the economic outlook are more than $600 billion of tax increases and spending cuts scheduled to take effect next year unless Congress acts. The Congressional Budget Office has said the fiscal tightening would probably push the economy into a recession next year.
Treasury purchases would constitute "insurance that if there's a failure to agree between Congress and the president, the Fed is out there to prevent an even bigger downdraft," Silvia said.
The FOMC will probably wait until its March 19-20 meeting before adopting thresholds on unemployment and inflation to indicate when it will consider raising the federal funds rate, according to the median estimate of surveyed economists.
Forty-eight of 49 economists say the Fed won't set the thresholds tomorrow. The Fed currently says it will keep its main interest rate near zero at least through mid-2015.
The Fed hasn't spelled out limits on the duration or size of its current accommodation, which was announced in September.
In the first round of quantitative easing starting in 2008, the central bank bought $1.25 trillion of mortgage-backed securities, $175 billion of federal agency debt and $300 billion of Treasuries. In the second round, announced in November 2010, the Fed bought $600 billion of Treasuries.
Posted 11 December 2012 - 06:18 PM
Posted 17 December 2012 - 01:51 PM
Federal Reserve Moves in Opposite Directions on Fixing the Economy
Here's a flash. Things aren't always as they seem in Washington.
Case in point: This week headlines around the world screamed that the Federal Reserve Board is making lowering unemployment, not controlling inflation, its key objective. It will continue holding down interest rates and expanding the money supply so long as unemployment remains above 6.5 percent. This means it will extend its unprecedented four years of quantitative easing indefinitely.
Yet on the same day some papers noticed that, as the Financial Times reported, "The US Federal Reserve is carrying out its first ever system-wide stress test of bank liquidity…", in effect requiring that banks increase reserves even more than they already have. In other words, even as the Fed doubles down on quantitative easing, it will also double down on a process that started with Dodd-Frank and the international banking agreement called Basel III and demand that banks up their holdings of cash and highly liquid assets (primarily government bonds) at the expense of loans, a process that to monetarists looks like the exact opposite of quantitative easing.
[See a collection of political cartoons on the economy.]
And with the government continuing to push banks back into the housing market as if no one has learned a thing from the crisis of 2008-9 and with major corporations and their stellar credit ratings continuing to be favorites of regulators as well as bankers, those who feel this tightening most painfully will be small and medium-sized businesses. But wait. Aren't those the kinds of enterprises that created all the net new jobs over the last three decades?
It is nothing new for the Fed to move in opposite directions.
Economist Steve Hanke is perhaps the world's leading expert on hyperinflation, which many worry will be the outcome of all the quantitative easing. He notes that since September 2008 the Fed's "balance sheet has increased roughly three and a half times… from about 6.5 percent of the total money supply… until now it's about 15 percent...." He calls these holdings "state," meaning government-issued, money, as opposed to the money created via lending, which he calls "bank" money.
[See a collection of political cartoons on the budget and deficit.]
And of bank money, he adds, regulation and rising reserve requirements "have in effect imposed ultra-tight monetary policy on the banking system and bank money… [w]hich accounts for 85 percent of the total money in the economy."
The upshot Hanke concludes is that "relative to trend we've got a deficiency of 7.5 percent in broad money." You would think that after four years the Fed would figure out this contradiction, and no doubt it has. So what is it actually up to?
Consider this: Four years ago, Fed Chairman Benjamin Bernanke and his colleagues were presented with two crises. The first was the collapse of the housing bubble. Brought on by the demands of congressional Democrats led by Rep. Barney Frank and then-Sen. Chris Dodd that banks become extensions of federal social policy, the housing bubble swept away tremendous volumes of bank capital when it burst. It wasn't that this bank or that bank was too big to fail, but that a vast number of banks were suddenly capital deficient and endangered. By creating large volumes of "state" money while restricting the expansion of "bank" money, the Fed has spent the last four years, in effect, recapitalizing the American banking system.
[Read the U.S. News Debate: Should There Be More Quantitative Easing?]
In its current phase, the second crisis also began in 2008—the crisis in government debt and unaddressed entitlement liabilities. The media is full of talk about the fiscal cliff. Will we go over it? Will we not? But if you are sitting at the Fed (and working closely, as Bernanke has throughout his tenure, with the secretary of the Treasury), you have to assume that, whatever the outcome of the current White House-Congress negotiations, the government's unprecedented volume of borrowing will continue indefinitely.
So, now, assume you are Chairman Bernanke. You ask yourself, "How do we finance all those deficits?" You answer, "What if we at the Fed print lots of 'state' money and buy the debt ourselves?" But then you think, "If we do that, how do we protect the nation from late '70s-early '80-style runaway inflation?" Then you think, "Bingo, we'll clamp down on 'bank' money?"
How simple. Two crises, one solution.
[Read the U.S. News Debate: Has the Federal Reserve Overstepped its Mandate?]
Here is how the Fed's words and actions of the last couple of days add up. Mr. Bernanke sees both crises continuing indefinitely. Announcing that lowering unemployment is the goal buys him time with his most worrisome Hill and White House critics but doesn't necessarily mean that "state" and "bank" money policies will move measurably relative to one another.
Bank capital will continue to build. The government will continue to be funded. Growth will continue to crawl.
Posted 17 December 2012 - 01:52 PM
WASHINGTON -- It was big news last week when the Federal Reserve announced that it wants to maintain its current low-interest rate policy until unemployment, now 7.7 percent, drops to at least 6.5 percent. The Fed was correctly portrayed as favoring job creation over fighting inflation, though it also set an inflation target of 2.5 percent. What was missing from commentary was caution based on history: the Fed has tried this before and failed -- with disastrous consequences.
By "this," I mean a twin targeting of unemployment and inflation. In the 1970s, that's what the Fed did. Targets weren't announced but were implicit. The Fed pursed the then-popular goal of "full employment," defined as a 4 percent unemployment rate; annual inflation of 3 percent to 4 percent was deemed acceptable. The result was economic schizophrenia. Episodes of easy credit to cut unemployment spurred inflation, which inspired tighter credit that boosted joblessness. By 1980, inflation was 13 percent and unemployment, 7 percent.
The Fed was in over its head. It didn't know enough to do what it (and many others) thought it could do. Today's problem is similar. Although the Fed has learned much since the 1970s -- including the importance of low inflation -- its economic understanding and powers are still limited. It can't predictably hit a given mix of unemployment and inflation. Striving to do so risks dangerous side effects, including a future financial crisis.
For proof of the Fed's limits, look to the Fed itself. Since the 2008-09 financial crisis, which the Fed didn't anticipate or prevent, it has repeatedly miscalculated. It's made heroic efforts to revive the economy, including keeping short-term interest rates near zero since late 2008 and pumping out more than $2 trillion by buying mortgage bonds and U.S. Treasury securities. But as Chairman Ben Bernanke conceded last week, the Fed has consistently overestimated the recovery's strength. Even if the Fed's policies were right, their impact has been exaggerated.
Throwing money at the economy has produced only modest gains. The money paid out to buy bonds has aimed, through reinvestment in the stock and bond markets, to boost stock prices and lower interest rates on other bonds. These changes are intended to stimulate spending. Many economists agree that more can be done. "Is the Fed running out of steam? To some extent," says Mark Zandi of Moody's Analytics. "But interest rates on 30-year fixed mortgages are 3.35 percent. They could be lower."
What might doom the Fed's ambitions?
One threat is irrelevancy. Credit is arguably so easy that the Fed can't do much more. Psychology counts. "What I see among small- and medium-sized businesses is rampant pessimism," says economist Allan Meltzer of Carnegie Mellon University. "With $1.5 trillion of excess bank reserves, it's hard to argue that there's a shortage of loanable funds." Fears about the "fiscal cliff" -- all the tax increases and spending cuts scheduled for early 2013 -- amplify this point.