Fed Signals Growth Return Insufficient to End Monetary Stimulus

By Scott Lanman
Sept. 24 (Bloomberg) -- The Federal Reserve signaled that the U.S. economy’s return to growth is insufficient to withdraw stimulus as officials seek to reduce the highest unemployment rate in a quarter century.
While the economy has "picked up," the central bank’s planned asset purchases will help ensure a "gradual return to higher levels of resource utilization," the Fed’s Open Market Committee said yesterday. Policy makers committed to complete their $1.25 trillion in purchases of mortgage securities and extended the end-date of the program to March from December.
"They’re going to be in that accommodative phase for a while," said Vincent Reinhart, a former Fed monetary-affairs director who’s now a resident scholar at the American Enterprise Institute in Washington. The Fed’s "tactical goal isn’t just to get to the rate of growth of potential," he said. "It’s to work down the level of slack."
The FOMC statement, while offering the most favorable economic outlook since Lehman Brothers Holdings Inc. failed a year ago, means Chairman Ben S. Bernanke may delay raising interest rates and shrinking the Fed’s $2.1 trillion balance sheet until he secures a recovery.
Policy makers, as part of a unanimous decision, kept the main interest rate in a range of zero to 0.25 percent and reiterated that rates will stay low for an "extended period."
The central bank pledged to purchase "a total of" $1.25 trillion of mortgage debt, changing prior language saying it will buy "up to" that amount.
Traders yesterday marked down expectations for Fed interest-rate increases next year, based on futures contracts on the Chicago Board of Trade.

Stocks, Treasuries

Treasuries rose yesterday, pushing the yield on the benchmark 10-year note down three basis points to 3.42 percent in New York, according to BGCantor Market Data. The Standard & Poor’s 500 Index lost 10.79, or 1 percent, to 1060.87, paring its gain this year to 17 percent.
The FOMC said the economy showed signs of "substantial resource slack." The unemployment rate rose to 9.7 percent last month, the highest since June 1983, when it reached 10.1 percent. Employers eliminated 216,000 jobs in August, the 20th straight month of losses, and the Fed acknowledged yesterday that businesses are "still cutting back on fixed investment and staffing, though at a slower pace."
Capacity utilization, the proportion of industrial volume in use, rose in August to 69.6 percent from 68.3 percent in June, its lowest level since record-keeping began in 1967. The figure averaged about 81 percent from 2005 to 2007.

‘Cost Pressures’

"Slack is important to their thinking about inflation and inflation expectations," said Mark Spindel, chief investment officer at Potomac River Capital LLC in Washington, a hedge fund with about $100 million under management.
"They are sending a clear message that rates will stay low for longer," said Spindel, a former deputy treasurer at the World Bank’s International Finance Corp.
The weakness in the economy is "likely to continue to dampen cost pressures" and keep inflation "subdued for some time," policy makers said yesterday. Public expectations for price trends are "stable," they said.
At the same time, housing market has started to stabilize.
Home prices rose 0.3 percent in July from the previous month, the Federal Housing Finance Agency said this week. Housing starts rose in August to the highest level in nine months.
"Activity in the housing sector has increased," the central bank said.

‘More Optimistic’

"They have gotten progressively more optimistic over the last several statements, and this is the most optimistic since the financial crisis intensified last September," said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York.
"The economic data will be improving quite sharply over the next few quarters," said Maki, a former Fed researcher.
Yesterday’s affirmation that the Fed would buy the full amount of mortgage backed securities eased concerns that any reduction of the program might undermine a recovery in the housing market. The Fed’s purchases of the securities have pushed down mortgage rates, helping spur demand for homes.
"They probably recognize exiting is much more difficult than entering into the program," said Torsten Slok, senior economist at Deutsche Bank AG in New York. "They’re very worried about what the reaction will be when it fades, so they’re pushing it into 2010," he said. "For now, that’s pushed the problem ahead of them."
The average rate on a 30-year mortgage dropped to 5.04 percent in the week ending Sept. 17 from 5.07 percent the week before, according to mortgage buyer Freddie Mac.
The Fed has announced $861.9 billion of mortgage-backed securities purchases and completed $685.1 billion. It’s bought
$125.2 billion of agency debt and $289.2 billion of the planned purchases of $300 billion in Treasuries, which will end next month.
The tapering in housing debt purchases will begin today, the New York Fed said in a separate statement after the meeting.