Fed likely to slow bond buys despite tepid economy
Once the Fed announces its decisions Wednesday, it will issue updated forecasts for the economy and Bernanke will hold a news conference.
Analysts expect the Fed to downgrade its economic outlook for 2013 from its previous forecast in June. That forecast estimated that the economy would grow at a still-sluggish annual rate between 2.3 percent and 2.8 percent this year. Through the first six months of 2013, the economy has grown at a much slower 1.8 percent rate.
Many think the Fed will try to cushion the response to a pullback in long-term bond purchases by stressing it has no intention of raising short-term interest rates anytime soon. The Fed has said it expects to keep its benchmark short-term rate near zero at least until the unemployment rate falls to 6.5 percent — as long as the inflation outlook remains mild.
The unemployment rate is now 7.3 percent, the lowest since 2008. Yet the rate has dropped in large part because many people have stopped looking for work and are no longer counted as unemployed — not because hiring has accelerated. Inflation is running below the Fed’s 2 percent target.
Any long-term reassurances from the Fed could face skepticism from investors who know that a new chairman might alter its policymaking. In addition, up to five new officials could join the Fed’s seven-member board next year.
The Fed has struggled at times to send a clear message about its likely timetable for changing policies. Yet in recent months, the Fed and Bernanke have been explicit that a pullback in bond purchases would likely start by year’s end and perhaps by September.
"This is the market’s consensus view, and Fed officials are the ones who have guided the market to that consensus," said Mark Zandi, chief economist at Moody’s Analytics. "At this point, the Fed doesn’t want to jumble its communications."
Investors have sent long-term rates up in anticipation of a slowdown in purchases. Since Bernanke first hinted in May that a pullback was likely by year’s end, the rate on the 10-year Treasury note has jumped from 1.63 percent in early May to 2.89 percent.
And long-term mortgage rates have surged more than a full percentage point since May, an increase that’s made home-buying more difficult for some.
David Jones, chief economist at DMJ Advisors, foresees the Fed cutting back on its purchases at a rate of about $10 billion at each meeting between now and mid-2014.
Even by that timetable, the Fed’s stock of Treasury and mortgage bonds will grow: The investment portfolio will likely near $4.5 trillion by next summer. It’s now a record $3.66 trillion — a four-fold increase from its level when the financial crisis erupted five years ago.
Even after new bond buying winds down, the Fed plans to keep reinvesting its bond holdings. It just won’t be adding to its stockpile. It will still be providing extraordinary support for the economy.
And yet some economists remain unconvinced that now is the time to slow the purchases.
"Interest rates have already gone up as a result of their just talking about bond reductions," said Sung Won Sohn, an economics professor at California State University’s Martin Smith School of Business. "If they actually began cutting bond purchases, that would push interest rates up more and damage the economy."
Wyss thinks Bernanke’s imminent departure is the main factor.
"If this were a decision based on economics, I think the Fed would wait, but given the politics of a new chairman having to go before Congress for confirmation, that could be an argument for moving now," Wyss said.