US Federal Reserve likely to reduce bond buying
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US Federal Reserve likely to reduce bond buying

Last Updated: Wednesday, September 18, 2013, 17:12
 
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US Federal Reserve likely to reduce bond buying
Washington: The US Federal Reserve is expected to begin its long retreat from ultra-easy monetary policy on Wednesday by announcing a small reduction in its bond buying, while stressing that interest rates will remain near zero for a long time to come.

Most economists expect the Fed to scale back its monthly purchases by a modest USD 10 billion, taking them to USD 75 billion and signaling the beginning of the end to an unprecedented episode of monetary expansion that has been felt worldwide.

The baby step would begin to provide a bookend of sorts to the central bank's response to the global financial crisis that reached fever pitch five years ago this week with the collapse of investment bank Lehman Brothers.

"It is an important milestone ... juxtaposed against five years ago, when the Fed began the huge expansion of its balance sheet," said Carl Tannenbaum, chief economist at Northern Trust in Chicago. "This is going to be the first step, potentially, in a very, very long walk."

The Fed will announce its decision in a statement following a two-day meeting at 2 p.m. (1800 GMT), and Fed Chairman Ben Bernanke will hold a news conference a half hour later. It is also set to release fresh quarterly economic and interest rate projections.

In slashing overnight rates to zero in late 2008, the Fed launched an extraordinarily bold campaign to shelter the US economy. The effort included three rounds of bond purchases that more than tripled its balance sheet to around USD 3.6 trillion.

The actions, unthinkable to many within the Fed prior to the crisis, sparked intense criticism from those who feared the measures would create an asset bubble or fuel inflation.

But the central bank's show of force was credited with saving the U.S. and world economies from a much worse fate.

With the US economy now on a somewhat steady, if tepid, recovery path and unemployment falling, policymakers have said the time was drawing near to begin ratcheting back their bond buying with an eye toward ending the program around mid-2014.

While US government bond yields and mortgage rates have shot higher in anticipation of less Fed support, the central bank will still be expanding its balance sheet for many more months as it tries to wean the economy and financial markets from its ever-expanding stimulus.

YELLEN AND FORWARD GUIDANCE

Fed Chairman Ben Bernanke, in what is likely his penultimate news conference before stepping down in January, is expected to reinforce the central bank's commitment to keep overnight rates near zero for a long time to come as a way to temper any jitters the bond market may feel.

The forward guidance on rates is aimed at holding down longer-term borrowing costs, which encompass investors' views on the path of short-term rates.

That task may have gotten easier after former Treasury Secretary Lawrence Summers withdrew from the race to replace Bernanke when his term ends on January 31, restoring current Fed Vice Chair Janet Yellen to the front-runner position.

Yellen, who would become the first woman ever to hold the job if nominated by President Barack Obama and confirmed by the US Senate, could be expected to maintain the policy path set by the Bernanke-led Fed. Investors and economists were less certain on where Summers might lead the central bank.

"I think that probably does add to the credibility of the forward guidance in terms of the greater expectation of continuity in the basic philosophy and direction of policy," said David Stockton, a former senior Fed economist.

"If there had been as much uncertainty about the transition as there was a week ago, that credibility may have been less secure," said Stockton, who is now a senior fellow at the Peterson Institute for International Economics in Washington.

The Fed has said it will not begin raising rates at least until the unemployment rate hits 6.5 percent, provided inflation does not threaten to pierce 2.5 percent. The jobless rate stood at 7.3 percent in August.

But 10-year bond yields have risen more than a percentage point since Bernanke initially discussed scaling back the Fed's bond purchases, a signal that investors had brought forward their anticipated lift-off date for overnight rates.

Some analysts wonder if the Fed might try to hammer home the message that rates would stay lower for longer by reducing the unemployment threshold to 6.0 percent.

But it could prove hard for Bernanke to muster sufficient support from other members of the central bank's policy-setting committee for such a move.

"They will be hesitant to put in any more explicit forward guidance," said Dean Maki, chief US economist at Barclays Capital in New York. "They really cannot credibly say a lot about 1-1/2 years from now."

Reuters


First Published: Wednesday, September 18, 2013, 09:15


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