Fed Seen Slowing Stimulus by Year-End

Fed policymakers aren't expected to announce any change after today's meeting.

Chairman Ben S. Bernanke will probably reduce the Federal Reserve’s monthly bond buying in the fourth quarter to $50 billion from $85 billion as he begins to unwind record stimulus, economists said in a Bloomberg survey.

Policy makers must find a way to slow the pace of purchases enough to signal confidence the economy is strengthening without prompting a sudden rise in interest rates, said former Fed economists Michael Feroli and Joseph LaVorgna. They said that probably means the Fed, which concludes a policy meeting today, will follow a three-step strategy to wind down bond buying.

“There is concern the first taper would be misinterpreted as the onset of a tightening cycle” and cause interest rates to go up, said Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. An initial reduction to $50 billion to $60 billion a month, followed by a second cut to $30 billion and then a halt to bond buying “would be enough of a runway to know and gauge the effects of what they’re doing, but not too long a runway where it’s a painfully interminable process.”

The Federal Open Market Committee plans to release a statement at 2 p.m. after a meeting in Washington. None of the 47 economists in the Bloomberg survey taken April 25-29 expects a decision at this week’s meeting to change the pace of purchases.

Withdrawing accommodation after an open-ended program of bond buying is “unprecedented territory” for the central bank, said LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. Cutting purchases by about a third would allow the Fed to gauge the reaction of the economy and investors. If the economy strengthens, the Fed could keep tapering purchases, he said. If interest rates rise and threaten growth, policy makers could renew easing.

“You want to see how the market is going to digest a cut in purchases so you want to do it in a way that minimizes the disruption,” said LaVorgna, who was among economists in the Bloomberg survey.

The Fed began purchasing $40 billion a month of mortgage-backed securities in September and announced in December additional purchases of $45 billion a month of Treasury securities.

The FOMC in a statement after its last meeting on March 20 reiterated a pledge to keep buying bonds until the labor market improves “substantially.” Bernanke said at a press conference the same day that policy makers are considering a proposal to “appropriately calibrate” bond purchases based on the performance of the economy, including the job market.

 

Quantitative Easing

The bond purchases, known as quantitative easing, have helped push up stock prices and reduce bond yields. The yield on the 10-year Treasury note yesterday was little changed at 1.67 percent in New York, near a low for 2013, as signs of weakness in the economy allayed concerns the Fed may curtail bond buying. The Standard & Poor’s 500 Index closed at a record high 1,597.57, as a rise in consumer confidence offset a drop in business activity.

The median estimate in the Bloomberg survey predicts a reduction in monthly purchases during the fourth quarter to $25 billion in Treasuries and $25 billion in mortgage-backed securities.

While too big a cut may trigger concerns that a policy tightening is imminent, too small a reduction would be difficult for investors to interpret, said Michael Gapen, senior U.S. economist and head of U.S. asset allocation strategy for Barclays Plc in New York.

St. Louis Fed President James Bullard has proposed the Fed alter purchases by $10 billion to $15 billion per meeting depending on the outlook for the economy. Such an approach may “put too much precision on it,” Gapen said.

“I can’t tell you there’s a meaningful economic difference between $85 billion a month and $70 billion a month,” said Gapen, a former Fed economist.

Fed Vice Chairman Janet Yellen and New York Fed President William C. Dudley have backed the idea of adjusting purchases, without providing an estimate of how much to shrink or enlarge them at each step.

Calibrating bond buying will “provide the public with information regarding the committee’s intentions and should reduce the risk of misunderstanding and market disruption as the conclusion of the program draws closer,” Yellen said last month in a speech in Washington.

The U.S. job market remains short of the FOMC’s goal of substantial improvement, with employers adding 88,000 positions in March, the fewest since June.

 

Jobs Report

The Labor Department on May 3 will probably say the unemployment rate in April remained unchanged at 7.6 percent as employers added 148,000 jobs, according to the median estimate in a separate Bloomberg survey.

The odds that easing will end early have declined, according to the economists in the survey, following weak payroll expansion and below-forecast economic growth of 2.5 percent in the first quarter. Only 11 percent expect the Fed to halt purchases in the fourth quarter compared with 22 percent in a March poll. Sixty-one percent are forecasting an end to the buying in the first half of 2014.

Bullard said in an April 3 interview with Bloomberg radio that bond buying is moving “full steam ahead.” The third round of quantitative easing will total $1.18 trillion, according to the survey. So far the purchases have pushed the Fed’s balance sheet to a record $3.32 trillion.

The Fed probably won’t abruptly halt bond purchases, said Stuart Hoffman, chief economist at PNC Financial Services Group Inc. in Pittsburgh and a participant in the survey. He predicts the Fed in its first move will reduce buying by half.

“The Fed has signaled in many ways that when they finally do see significant improvement, they won’t go cold turkey” on bond purchases, he said.

 

Bloomberg News

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