News Column

Is the Fed Buying Bonds Again?

Dec. 10, 2012

By Paul Davidson

Federal Reserve

The Federal Reserve is expected to take another step Tuesday to stimulate the lackluster recovery by agreeing to buy more Treasury bonds to push down long-term interest rates.

The Fed also could consider new ways to signal when it expects to raise a benchmark short-term interest rate, now near zero. Such communication can push up rates even before the Fed takes any action.

Both initiatives are aimed at keeping borrowing costs low for consumers and businesses to speed growth.

The modest job growth reported by the Labor Department on Friday underscores two things: The decision to buy Treasuries will likely be an easy call, while fine-tuning the communication strategy may be trickier and may well be put off until 2013.

Employers added 146,000 jobs last month, Labor said, and the unemployment rate fell from 7.9% to 7.7%.

In September, the Fed said it plans to continue buying government bonds until the labor market improves "substantially." At that time, it announced the purchase of $40 billion a month in mortgage-backed securities to lower mortgage rates.

A separate program, known as Operation Twist, to purchase $45 billion a month in long-term Treasuries and sell a similar amount of short-term notes, ends this month. Since the Fed doesn't have enough short-term Treasuries left in its portfolio to keep the program going, many economists expect it to simply continue buying $45 billion a month in long-term Treasuries.

"They're prepared to do whatever's necessary" until the job market picks up significantly, says economist Nigel Gault of IHS Global Insight.

San Francisco Fed President John Williams has backed that approach.

Yet, Treasury purchases without offsetting sales would expand the Fed's bond portfolio, pumping more cash into the economy but making it tougher to eventually sell bonds to head off inflation. In a recent speech, St. Louis Fed President James Bullard said outright purchases would amount to a policy change.

Tim Duy, author of the Fed Watch blog and a University of Oregon economist, anticipates $25 billion to $40 billion in monthly purchases.

Fed policymakers also have said recently they favor citing economic thresholds to signal when they plan to raise short-term interest rates. In recent months, they've said they expect rates to stay near zero until at least mid-2015. But Bullard says that's inadequate because financial markets realize the date could change due to economic conditions.

Bullard and other Fed members instead suggest setting thresholds of 6.5% unemployment and 2.5% annual inflation for when the Fed would consider raising rates. Yet, Bullard says investors may mistakenly believe the thresholds would automatically force rate increases even if other economic data are weak.

For example, November's unemployment rate fell not because of job growth but because 350,000 people stopped working or looking for work.

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Source: Copyright USA TODAY 2012

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