Wednesday, September 15, 2010

PREVIEW-Fed seen treading water, weighing easing

WASHINGTON: The Federal Reserve is expected to tread water at a policy-setting meeting next week with a renewed promise to keep its portfolio from shrinking but no new steps to ease monetary policy, according to a Reuters report on Tuesday, Sept 14.

The meeting is set for next Tuesday, Sept 21. Lack of action, however, should not be construed as indicating a lack of debate. Policymakers need to decide if and when to launch further large-scale asset purchases to support the sluggish recovery.

The central bank acknowledged in August that the U.S. recovery had lost momentum and Chairman Ben Bernanke said the Fed would renew efforts to stimulate growth if the outlook soured appreciably.

Views differ among Fed officials about whether persistently high unemployment merits more aggressive policy intervention. Some believe the economy's growth path has flattened, requiring more stimulus lest it stall altogether.

However, others maintain a parade of gloomy economic reports over the summer mark no more than a soft patch in a recovery that will regain traction in 2011. Data in the past couple of weeks, including a stronger-than-expected reading on private-sector jobs growth, may bolster that line of thinking.

Following are possible outcomes from the meeting:


Policymakers could conclude they have too little information to know whether the outlook has deteriorated significantly, requiring more stimulus.

They could provide some clues in their statement to indicate whether they have downgraded their forecast for 2011, which would suggest that they are leaning to providing additional easing even though it is too soon to act.

Alternatively, they could signal that recent reports suggest the recovery now looks better positioned to gain momentum next year, which would suggest action is less likely.

Probability: high to moderate.

What markets would do: Markets largely expect no further easing at this meeting. Fed inaction could be seen as confirmation the threat of a double-dip recession has receded, and stocks could rally. Bond prices and the dollar could fall as investors move to riskier assets.


Policymakers may worry that already weak hiring could fizzle altogether and that already low inflation could move even lower, raising the prospect of a damaging downward cycle of falling prices.

In this case, the Fed could decide its best strategy is to get out in front and take steps to stimulate growth.

However, officials could decide the Fed need not tie its hands by saying it is willing to purchase a large amount of securities, which markets would then come to expect it to fulfill in the full amount.

Instead, the Fed would announce a limited amount of one-time purchases and say any further buying would depend on the evolution of the outlook.

St. Louis Federal Reserve Bank President James Bullard said this would be the route to go if the Fed were to decide further easing necessary.

Probability: low.

What markets would do: Further easing would be supportive for bonds, but a modest step might disappoint and push prices lower. It could also fuel stock gains because much of last year's rally was on the back of Fed asset purchases. The dollar could gain because a Fed move would suggest further worries for the economy and attract safe haven investors.


If policymakers conclude further easing is necessary, they may decide to go at it with both barrels blazing.

Since it took $1.7 trillion to lower the yield on the 10-year Treasury by roughly a half-percentage point, they could announce additional purchases of up to $500 billion to $1 trillion more in easing to cut borrowing costs and stimulate growth.

Some analysts think this is the most likely option for further easing, but that the case has not yet built to force the Fed's hand.

Probability: low.

What markets would do: Further aggressive quantitative easing could boost both stocks and bonds. It could also cause a decline in the dollar as bond yields fall, but if markets worry the Fed is seriously worried about a new downturn, investors could move to safer assets and the dollar could gain. - Reuters

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