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Posted: Tuesday, October 23rd 2012 at 9:15am

Fed likely to send wait-and-see signal at meeting

By The Associated Press
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WASHINGTON (AP) -- Six weeks ago, the Federal Reserve unveiled its latest plan to invigorate the U.S. economy. This week, the Fed will likely send a simple message:

Give that plan time to work.

No major announcements are expected when the Fed's latest two-day policy meeting ends Wednesday. Instead, officials will likely affirm their plan to buy mortgage bonds as long as necessary to make home buying more affordable, keep short-term interest rates at record lows through mid-2015 and take other stimulative steps if hiring doesn't pick up.

Those policies are intended to support an economy that's shown flashes of strength but isn't growing fast enough to create many jobs or to increase Americans' income. The economy grew at a meager 1.3 percent annual rate in the April-June quarter.

Economists think it grew slightly faster in the July-September quarter. Yet many employers remain wary of hiring, in part because of tax increases and spending cuts set to kick in next year and in part because of a slowing global economy.

The $40 billion-a-month in bond purchases the Fed launched last month are designed to lower interest rates and cause stock and home prices to rise, creating a "wealth effect." When consumers feel wealthier, they're typically more willing to spend, thereby boosting the economy.

The Fed made clear it would likely hold rates low even after the economic recovery has strengthened. That was a signal that it will keep intervening until the economy grows fast enough to reduce unemployment sharply.

Now, the Fed likely wants to wait to assess the effects of its policies before deciding whether to take further action.

There's another reason to stand down for now: A debate is raging inside the Fed over whether its actions are doing much, if any, good. The Fed's moves last month were approved 11-1, with Jeffrey Lacker, president of the Richmond Federal Reserve Bank, dissenting. Since then, some other regional Fed presidents have expressed their discomfort.

The critics note that interest rates have already been at or near all-time lows. They worry that the Fed's injection of steadily more money into the financial system will eventually ignite inflation or create dangerous bubbles in the prices of stocks or other assets.

Since the 2008 financial crisis erupted, the Fed has bought more than $2 trillion in Treasurys and mortgage bonds to try to drive down long-term borrowing rates and accelerate the economy. Its portfolio of investments stands at $2.85 trillion - more than three times its size before the crisis.

Since the Fed unveiled its latest plans last month, the average rate on a 30-year fixed mortgage has touched 3.36 percent - the lowest since mortgage buyer Freddie Mac began keeping records in 1971. Cheap loans have helped lift home sales, prices and construction - key pillars of the housing market's gradual but steady comeback.

Super-low rates have shrunk many bond yields close to zero and led some investors to shift money into stocks, whose prices have surged. Higher stock prices may help explain some of the recent gains in consumer confidence and retail spending.

One part of the Fed's drive to keep long-term borrowing rates down has been a program it began a year ago to sell short-term securities and use the proceeds to buy $45 billion in longer-term securities each month. This program is called "Operation Twist."

When Operation Twist is combined with the mortgage bond purchases the Fed launched in September, the central bank is buying $85 billion in long-term bonds each month.

Operation Twist is to expire at year's end, when the Fed will run out of short-term securities to sell.

Many analysts think the Fed may announce at its next policy meeting in mid-December that it will replace Twist with some other bond purchase program. Fed officials could decide to start buying enough new Treasurys to keep their total long-term-bond purchases at around $85 billion each month.

If the Fed decided instead to do nothing further, it might unsettle investors, said David Jones, chief economist at DMJ Advisors. A signal to financial markets that the Fed was reducing its bond purchases could send long-term rates up and stock prices down.

For now, investors seem pleased that the Fed is on a bond-buying spree.

The central bank is right to signal its commitment to support the economy until the job market strengthens, said Brian Bethune, an economics professor at Gordon College in Massachusetts.

Economic growth remains subpar despite the stronger housing market, a decline in the unemployment rate to 7.8 percent and retail sales in August and September that were the best back-to-back monthly gains in two years, according to Commerce Department data.

"We still have a weak economy, but it would have been flirting much closer to a recession if the Fed had not been as aggressive as it has been," Bethune said.
Associated Categories: Business News

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