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Fed unlikely to curtail stimulus despite rising doubts

Section: Daily Dispatches

By Pedro Nicolaci da Costa
Friday, February 22, 2013

WASHINGTON -- U.S. Federal Reserve officials are likely to press on with their bond-buying stimulus program even though some harbor growing concerns the purchases could fuel an asset bubble or inflation if pushed too far.

A full-throated debate among U.S. central bankers over the wisdom of ongoing quantitative easing, or QE, sent U.S. stock prices down sharply when minutes of the meeting were released on Wednesday.

Investors were right to assume the Fed is treading more carefully as it weighs the risks of its effort to spur a faster economic recovery, but that does not mean policymakers will conclude the costs outweigh the benefits.

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Indeed, the officials who have voiced the greatest angst over the central bank's course do not currently have a vote on the policy-setting panel and the Fed's two most influential officials -- Chairman Ben Bernanke and Vice Chairman Janet Yellen -- are seen as committed to the bond-buying plan.

"It is not an even discussion in the sense that these two sides on the committee do not have equal weight," said Dean Maki, chief economist at Barclay's Capital in New York. "Bernanke and Yellen are strong advocates of QE."

The Fed has more than tripled the size of its balance sheet since 2008 to around $3 trillion through a series of bond buying programs and it opted in January to keep purchasing assets at an $85 billion monthly pace until the labor market outlook improved substantially.

But the minutes highlighted deep divisions among the 19 policymakers at the central bank.

"A number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the (policy-setting) committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred," the minutes said.

That tone helped drive the sharpest selloff in the S&P 500 in more than three months and went on to hit risky assets worldwide as investors questioned their assumptions about how long the Fed would keep pumping money into the economy.

Economists will now look for clues to the Fed's course from congressional testimony Bernanke is set to deliver on Tuesday and Wednesday. They could be disappointed, since the Fed chief rarely likes to get ahead of the central bank's policy panel.

Publicly, officials have raised a range of concerns from rising prices for agricultural land to the possibility they could roil markets when it comes time to sell bonds to shrink the Fed's balance sheet.

Research from Fed staffers has flagged both the potential risk that the central bank could face losses on its portfolio when the time comes to tighten policy and a troubling tendency of corporate bond investors to move as a herd.

The staff focus suggests those issues are resonating among officials on the Fed's seven-person Washington board, which dominates the policy-setting process. Indeed, Fed Governor Jeremy Stein, a board newcomer, focused on the risks of overheating in markets for corporate debt and leveraged loans in a speech earlier this month.

Despite the hand-wringing, the U.S. economy still appears in need of help. Economic growth braked sharply in the fourth quarter and the jobless rate edged up in January to 7.9 percent.

With the prospect of deep government spending cuts looming and a possible market-wracking showdown over the government's debt limit also on the horizon, the Fed has ample reason to keep its stimulative policy in place.

"They probably don't want to talk about easing back on the gas when fiscal policy is tightening perhaps very abruptly in the next few months," said Cary Leahey, senior advisor at Decision Economics.

Atlanta Fed President Dennis Lockhart, who does not have a vote on monetary policy this year but who is a centrist who tends to align with the board, said the cost-benefit calculus still amply favors ongoing monetary easing.

"I would not say at this point that, in any respect, the costs, which are largely longer-term and speculative, outweigh the benefits of maintaining a highly accommodative climate," he told Reuters on Tuesday.

While "many" Fed officials voiced concern over the potential costs of further asset purchases, it was an unspecified "number" that felt they might need to be dialed back or ended before the economic objectives were achieved.

That message was blunted by a warning from some policymakers about the dangers of ending the bond buys prematurely.

"Several others argued that the potential costs of reducing or ending asset purchases too soon were also significant," the Fed said.

In addition, some analysts noted that the minutes of the central bank's previous meeting in December said several officials thought bond purchases might need to slow or halt well before year end. In their view, the absence of a calendar reference in the latest minutes arguably made them more dovish.

"There's a good likelihood the Fed will still be in a full-bore accommodative mode through the end of the year," said Robert Tipp, chief investment strategist at Prudential Fixed Income in Newark, New Jersey.

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