In the U.S.: Bernanke Makes Case for More Bond Buying

26 January 2012

Fed willing to do what it takes…which number QE is this again?

Ben S. Bernanke laid the groundwork for a third round of large-scale asset purchases should unemployment remain higher than the Federal Reserve would like while inflation falls below a newly-established target.

The Federal Open Market Committee “recognizes the hardships imposed by high and persistent unemployment in an underperforming economy, and it is prepared to provide further monetary accommodation,” Bernanke said yesterday at a press conference in Washington.

Stocks and Treasuries rallied after policy makers said the benchmark interest rate would stay low until at least late 2014, pushing back a previous date of mid-2013. Fed officials also lowered their projections for economic expansion and inflation for this year and next.

“It was an unambiguous, aggressive statement,” said Julia Coronado, chief economist for North America at BNP Paribas in New York. “My expectation is that we are going to get quantitative easing three in April,” she said, referring to a third round of bond buying.

The U.S. central bank’s “two main tools” to boost growth are asset purchases and communications, and bond buying is “an option that is certainly on the table,” Bernanke said. “The unemployment level is elevated and the inflation outlook is subdued.”

Policy makers yesterday set a long-term goal of 2 percent inflation, and forecast that price increases would fall short of that target this year and next. The personal consumption expenditures price index (SPX) climbed 2.5 percent for the 12 months ending in November.

Pushing Transparency

Setting an inflation target was a longtime aim for Bernanke, a former Princeton University professor who mentioned it in his nomination hearing in 2005 and who has pushed the Fed to be more transparent in its dealings with the public.

“If there’s a need to let inflation” return “a little more slowly to target in order to get a better result on employment, then that’s something that we would be willing to do,” Bernanke said.

Inflation will range from 1.4 percent to 1.8 percent this year, and 1.4 percent to 2 percent in 2013, Fed officials forecast. In November, they projected inflation of 1.4 percent to 2 percent in 2012, and 1.5 percent to 2 percent next year.

“You have a 2 percent inflation target and guess what: you are below target” in their central tendency forecast for this year, said Roberto Perli, managing director of policy research at International Strategy and Investment Group Inc. in Washington. “If the fourth quarter’s growth is not sustained, and inflation remains subdued, then quantitative easing three in the spring is a good bet.”

Picking Up Speed

The Fed pushed back its horizon for the first interest-rate increase since June 2006 even as recent reports on manufacturing, housing and employment indicated that the economy was picking up speed as the new year began.

Employers added 200,000 jobs in December, twice the previous month’s pace, and the unemployment rate dropped to 8.5 percent from 8.7 percent the month before. Household wealth has also gotten a boost from rising stock prices, with the Standard & Poor’s 500 Index of stocks climbing 5.4 percent this year through yesterday.

“There has certainly been some encouraging news recently,” Bernanke said. Still, “we continue to see headwinds from Europe, coming from the slowing global economy and some other factors as well.”

Forecasts Lowered

Fed officials lowered their forecast for growth this year to 2.2 percent to 2.7 percent, down from a projection of 2.5 percent to 2.9 percent in November. They predicted the economy next year will expand 2.8 percent to 3.2 percent, compared with a previous forecast of 3.0 percent to 3.5 percent.

Bernanke has “a very dovish attitude,” said Robert Eisenbeis, a former research director at the Federal Reserve Bank of Atlanta who’s now chief monetary economist for Sarasota, Florida-based Cumberland Advisors. “They downplayed the extent to which the economy seemed to be doing a little better and said the employment situation is a major concern.”

Additional asset purchases might fan criticism of the Fed that has extended to the presidential campaign trail. Republican candidates Mitt Romney and Newt Gingrich have said they wouldn’t keep Bernanke, 58, whose four-year term as Fed chairman expires on Jan. 31, 2014.

“I’m not going to get involved in political rhetoric,” Bernanke said in response to a question about whether he’d resign if a Republican were elected president in November and asked him to do so. “As long as I’m here, I will do everything I can to help the Federal Reserve achieve its dual mandate of price stability and maximum employment.”

Political Backlash

Bernanke’s second round of bond buying, called QE2 by analysts and traders, sparked the harshest political backlash against the Fed in three decades, with Republican lawmakers saying the program risked accelerating prices.

Yesterday’s extension of the commitment to keep rates low reduced borrowing costs in the bond market. The yield on the current five-year Treasury note fell 10 basis points to 0.80 percent after touching the record low of 0.76 percent.

This latest stimulus step was intended “to convey to the market the extent to which there is support on the committee for maintaining rates at a low level for a significant time,” Bernanke said.

Lacker Dissents

Richmond Fed Bank President Jeffrey Lacker dissented from yesterday’s decision because he “preferred to omit the description of the time period over which economic conditions are likely to warrant exceptionally low levels of the federal funds rate,” according to the FOMC statement.

In August, the Fed pledged to keep its benchmark rate “exceptionally low” until mid-2013, and in September it decided to replace $400 billion of short-term debt in its portfolio with longer-term Treasuries in an effort to lower borrowing costs even more. The moves followed two rounds of large-scale asset purchases totaling $2.3 trillion that ended last June.

The 2013 rate pledge and the maturity-extension program, dubbed Operation Twist, drew three dissents, the most since 1992.

Bernanke “may have his work cut out for him to convince the holdouts on the committee that a double dose of QE is necessary,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. “One thing is for sure, and that is the Fed Chairman is itching to do more.”


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