Wednesday, 31 July 2013

Fed Sees Risk of Disinflation, Maintains Bond Buying Pace

By Jeff Kearns & Joshua Zumbrun - Jul 31, 2013 11:00 PM GMT+0400
The Federal Reserve said persistently low inflation could hamper the economic expansion and pledged to keep buying $85 billion in bonds every month.
“The committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term,” the Federal Open Market Committee said today at the conclusion of a two-day meeting in Washington.
Fed Keeps $85 Billion Bond Buying Pace, Sees Disinflation Risk Federal Reserve Board Chairman Ben Bernanke in Washington, DC. Photographer: Win McNamee/Getty Images
Fed Keeps $85 Billion Bond Buying Pace, Sees Disinflation Risk Workers prepare to mount the side panel of a semi trailer to the frame at the Wabash National Corp. facility in Lafayette, Indiana. Photographer: Daniel Acker/Bloomberg
Fed Keeps $85 Billion Bond Buying Pace, Sees Disinflation Risk Policy makers left unchanged their commitment to hold the target interest rate near zero as long as the jobless rate remains above 6.5 percent and the outlook for inflation over one to two years doesn’t exceed 2.5 percent. Photographer: Tim Boyle/Bloomberg
Chairman Ben S. Bernanke and his colleagues are debating when employment gains will be sufficient to warrant tapering bond buying that has swelled the Fed’s balance sheet to a record $3.57 trillion. Some policy makers have said the purchases, aimed at fueling growth and reducing 7.6 percent unemployment, risk creating asset-price bubbles.
The statement contained no new language on the conditions for maintaining the current pace of asset purchases. The Fed repeated the pledge it has used since September that it will continue the purchases until the U.S. labor market outlook has improved substantially.
“A September tapering announcement still seems likely,” saidMark Vitner, a senior economist at Wells Fargo Securities LLCin Charlotte, North Carolina. The FOMC is next scheduled to meet Sept. 17-18 in Washington.

‘Bottom Line’

“The bottom line for the Fed is the downside risks for the economy are diminishing,” he said. “If price gains decelerate to the point they worry about deflation, that might give them some pause” on tapering.
Stocks remained higher and Treasuries pared losses after the statement. The Standard & Poor’s 500 Index rose 0.7 percent to 1,697.21 at 2:49 p.m. in New York. The yield on the 10-year Treasury note was 2.6 percent compared with 2.61 percent yesterday.
Price increases have stayed below the central bank’s 2 percent target for more than a year. Bernanke told lawmakers July 17 that low inflation poses a risk to the economy, and policy makers “will act as needed” to ensure it rises toward their goal.
St. Louis Fed President James Bullard dissented from the previous Fed statement, saying the committee should “signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings.” He didn’t dissent today.

New Language

The Fed statement’s new language on the risks of too-low inflation language may have been included in part to satisfy Bullard’s concerns after his dissent at the previous meeting, Vitner said.
The central bank said its bond purchases will remain divided between $45 billion a month ofTreasury securities and $40 billion a month of mortgage-backed securities. The Fed also will continue reinvesting securities as they mature.
Policy makers also left unchanged their commitment to hold the target interest rate near zero as long as the jobless rate remains above 6.5 percent and the outlook for inflation over one to two years doesn’t exceed 2.5 percent.
The Fed said that the economy “expanded at a modest pace during the first half of the year.” In the previous statement, it described the expansion as “moderate.”
Housing has been “strengthening, but mortgage rates have risen somewhat, and fiscal policy is restraining economic growth,” the Fed said in its statement.

George Dissents

Kansas City Fed President Esther George dissented for the fifth meeting in a row, continuing to cite concern record accommodation may create financial and economic imbalances and increase long-term inflation expectations.
Bernanke, 59, said on June 19 that the FOMC may start scaling down bond buying later this year and halt it around the middle of 2014 as long as the economy performs in line with the committee’s expectations.
In semi-annual testimony to Congress on July 17, Bernanke said the labor market is “improving gradually” and that asset purchases “could be reduced somewhat more quickly” if the economy improved faster than expected. At the same time, he said the current pace of purchases “could be maintained for longer” if the employment outlook worsens.
None of the 54 economists in a July 18-22 Bloomberg News survey said they expected the central bank to alter the pace of purchases today. Fifty percent forecast that the Fed will first reduce bond buying at its Sept. 17-18 gathering.

GDP Report

Policy makers concluded their meeting today after a Commerce Department report today showed the world’s largest economy expanded at a 1.7 percent annual rate in the second quarter, more than economists forecast, as companies accumulated inventories at a faster pace. Growth in the first quarter was revised down to a 1.1 percent rate.
The gain in second-quarter gross domestic product showed the economy is overcoming the drag created by an increase in the payroll tax that took effect in January as well as across-the-board federal budget cuts known as sequestration, which began in March.
Growth will quicken as the impact from budget cuts wanes, Bernanke said in his congressional testimony. FOMC participants growth of 2.3 percent to 2.6 percent this year. Given today’s GDP report, the economy would have to expand 3.2 percent in the second half to meet the lower end of Fed forecasts.

‘Body Blow’

“We threw a pretty serious body blow to the economy this year in terms of the tax hikes and budget cuts,” said Josh Feinman, the New York-based global chief economist for Deutsche Asset & Wealth Management, which oversees $400 billion. “That’s taken a toll on growth in the first half of the year, and it’s going to have some lingering effects into the second half.”
A Labor Department report in two days may show that employers added 185,000 workers to payrolls in July and the jobless rate fell to 7.5 percent from 7.6 percent, according to the median forecasts in a Bloomberg survey of economists.
“There seems to be an increasing perception that the domestic economy is doing quite well,”Andrew Wilkinson, the chief economic strategist at Miller Tabak & Co. in New York, said before the FOMC statement. “That was really played out in payrolls.”
Payrolls have risen an average of 201,830 per month over the past six months. U.S. employers added 195,000 workers in June for a second straight month, the Labor Department said July 5, capping 12 months of advances above 100,000 for the longest such streak since May 2000.

Jobless Rate

At the same time, the jobless rate remains well above the Fed’s long-term unemployment forecast of 5.2 percent to 6 percent. Inflation is also lagging behind the Fed’s 2 percent goal: consumer prices rose 1 percent in May from a year earlier, according to an index followed by the Fed.
Borrowing costs have risen on speculation that an improving economy will prompt the Fed to taper bond buying.
The yield on the 10-year Treasury note soared to an almost two-year high of 2.75 percent on July 8 from 2.19 percent on June 18, the day before Bernanke said the Fed may consider reducing bond purchases this year if the economy performs in line with the central bank’s forecast. The yield rose yesterday 0.01 percentage point to 2.61 percent.
U.S. stocks have rallied amid better-than-estimated corporate earnings. The Standard & Poor’s 500 Index advanced 18 percent this year through yesterday.
Bernanke lowered the Fed’s target interest rate near zero in December 2008 and has since embarked on three rounds of asset purchases to spur a recovery from the deepest recession since the Great Depression and keep the economy expanding.

Third Round

The third round of quantitative easing may mark Bernanke’s final stimulus campaign. His term as Fed chairman ends in January, and President Barack Obama said in an interview last month that Bernanke has been at the Fed “longer than he wanted.” Larry Summers, former director of Obama’s National Economic Council, and Fed Vice Chairman Janet Yellen are the top candidates to succeed him.
Speculation Fed purchases may slow has also lifted mortgage rates. The interest rate on a 30-year fixed home loan climbed to 4.31 percent last week, according to data compiled by Freddie Mac. The rate jumped a record 35 percent in 10 weeks ended July 11 to a two-year high of 4.51 percent, the data show.
The increase hasn’t derailed a housing-market rebound that has helped fuel economic growth. Sales of new homes rose in June to the highest level in five years, pointing to gains in residential construction that will support the expansion in the second half of the year.

Home Prices

The S&P/Case-Shiller index of home prices increased 12.2 percent in the 12 months through May, a report showed yesterday.
AvalonBay Communities Inc. (AVB), the second-largest U.S. apartment real estate investment trust by market value, exceeded analyst estimates in its second-quarter earnings report and said rental housing is showing “strong” fundamentals.
“The U.S. economy is better positioned for growth today than it has been at any time since the downturn,” Timothy Naughton, chief executive officer of the Arlington, Virginia-based company, said in a July 25 earnings call. “Growing confidence combined with significant improvements in consumer and corporate balance sheets are translating into stronger consumption and investment.”
The FOMC began its third round of so-called quantitative easing in September with $40 billion in monthly mortgage bond purchases, adding $45 billion in monthly Treasury purchases in December.
The central bank will probably buy a total $1.32 trillion in bonds under its current purchase program, according to the median estimate in the Bloomberg survey. It will probably halt the asset purchases in the second quarter of next year, according to half of the economists.
-- With assistance from Steve Matthews in Atlanta. Editors: James Tyson, Christopher Wellisz
To contact the reporters on this story: Jeff Kearns in Washington at; Joshua Zumbrun in Washington at
To contact the editor responsible for this story: Chris Wellisz at