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Fed Set to Buy Billions in Bonds to Revive Economy

Wednesday, 03 November 2010 10:12 AM

The Federal Reserve is expected to announce a controversial policy on Wednesday to buy billions more dollars of government bonds in an attempt to breathe new life into the struggling U.S. economy.

The well-telegraphed decision would be aimed at further lowering borrowing costs for consumers and businesses that are still suffering from the worst recession since the Great Depression, though there are doubts about its effectiveness.

With the U.S. economy expanding at only a 2 percent annual pace in the third quarter of this year and the jobless rate seemingly stuck around 9.6 percent, the Fed has come under pressure to do more to stimulate business activity.

Economists expect a new round of Treasury purchases to total about $500 billion over a six-month period, a policy known as quantitative easing. Officials, who have been divided over the wisdom of the move, are also likely to signal the operation can be ramped up if needed.

The Fed cut overnight interest rates to near zero in December 2008 and has already bought about $1.7 trillion in U.S. government debt and mortgage-linked bonds.

"The Federal Reserve's proposed policy of quantitative easing is a dangerous gamble with only a small potential upside benefit and substantial risks of creating asset bubbles that could destabilize the global economy," Harvard University economist Martin Feldstein wrote in the Financial Times on Wednesday.

"Although the U.S. economy is weak and the outlook uncertain, QE is not the right remedy," said the former president of the U.S. National Bureau of Economic Research and former chief economic adviser to President Ronald Reagan.

The Fed, which resumed a two-day meeting at 9 a.m. (1400 GMT) is expected to announce its decision at around 2:15 p.m. (1815 GMT).


Markets have already seen sharp moves in anticipation of the Fed's expected resumption of bond purchases. U.S. stocks and government bonds have rallied, while the dollar has taken a drubbing in advance of the decision.

"We expect the statement will express a willingness — but not necessarily a bias — to further increase asset purchases if warranted by economic conditions," said Michael Feroli, chief U.S. economist at JPMorgan in New York.

Stocks have also been supported by expectations — now validated — that Republicans, viewed as more pro-business by investors, would seize control of the House of Representatives and pick up Senate seats in elections on Tuesday that were largely cast as a referendum on the economy.

As Republicans campaigned on a platform for smaller government, Congress may be less likely to offer fresh stimulus spending if the economy sputters, leaving the Fed as the primary source of support.

With the prospect of a long period of ultra-low returns in the United States, investors have flocked to emerging markets, pushing those currencies higher. Emerging economies, worried about a loss of export competitiveness, have cried foul.

"We are all under attack by the relaxed monetary policy of the United States," Colombian Finance Minister Juan Carlos Echeverry told investors on Tuesday.

The Bank of Japan, which meets on Thursday and Friday, is also poised to launch a new round of bond buying.

The European Central Bank and Bank of England also meet this week, but are not expected to make any changes to policy for the time being.


As things now stand, the U.S. economy is not growing quickly enough to put a dent in the unemployment rate, although a report on Wednesday suggested private sector hiring is picking up, albeit slowly.

The data from employment services firm ADP Inc. comes ahead of a U.S. government report on Friday that is expected to show overall job growth in October for the first time in five months.

With 14.8 million Americans unemployed, factories operating well short of capacity and inflation well below the 1.7 percent to 2.0 percent range the Fed shoots for, some officials see the risk of a vicious deflationary cycle where consumers hold off on purchases, choking off economic growth.

Fed Chairman Ben Bernanke laid the groundwork for a further round of bond purchases earlier this year by arguing the central bank was falling short of its twin objectives — price stability and full employment.

Further bond purchases, however, are viewed with a skeptical eye by many members of the Fed, and heated debate is expected.

The Fed owns roughly 12.5 percent of all outstanding Treasury bonds and notes. If it were to buy $1 trillion more, as some economists expect it eventually will, the portion of its holdings compared with all outstanding Treasuries could jump to 27 percent.

The Treasury's Borrowing Advisory Committee of government bond dealers expressed concerns about the possibility that a shortage of available bonds could cause market disruptions, according to minutes from its November 2 meeting.

Some economists, and some Fed policymakers, also worry further purchases could jeopardize the central bank's credibility if the impact proves small. In addition, there are concerns the Fed's bloated balance sheet may set the stage for rampant inflation once the recovery gains traction.

Kansas City Fed President Thomas Hoenig, who is concerned the Fed's easy money policies are prelude to yet another boom and bust cycle, said on October 25 that further easing would be "a bargain ... with the devil."

© 2018 Thomson/Reuters. All rights reserved.

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The Federal Reserve is expected to announce a controversial policy on Wednesday to buy billions more dollars of government bonds in an attempt to breathe new life into the struggling U.S. economy. The well-telegraphed decision would be aimed at further lowering borrowing...
Wednesday, 03 November 2010 10:12 AM
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