Fed ponders more easing as economy stumbles

The Federal Reserve meets on Tuesday to consider, and perhaps even adopt, additional measures to prop up a softening U.S. economic recovery.

Data since the U.S. central bank's last policy-setting meeting in late June has been decidedly weak. Consumer spending is petering out, and manufacturing, which had led the recovery, is losing steam. The unemployment rate is stuck at 9.5 percent, with firms showing a distinct reluctance to hire.

With U.S. interest rates already effectively at zero percent, the central bank is out of easy policy options. Top Fed officials argue, however, they can do more to fight renewed economic weakness, including reinvesting proceeds from maturing mortgage bonds back into that market.

The Fed could decide to announce such a shift on Tuesday, although it may simply decide to nod to mounting risks and lay the groundwork for a possible eventual return to easing in its post-meeting statement, which is expected around 2:15 p.m.

"We'll be looking for some acknowledgment about how growth appears to have slowed," said Jay Bryson, global economist at Wells Fargo Securities in Charlotte, North Carolina.

Reinvesting proceeds as mortgage bonds mature could prevent a "passive" tightening of monetary policy, although the impact on overall financial conditions would be minimal.

Other options for the Fed include lowering the rate it pays banks to park their excess reserves at the central bank, currently at an already low 0.25 percent, or somehow redoubling its already stated commitment to keep interest rates low for "an extended period."

"They have the ammo, the question is how effective it is," Bryson said.

Ultimately, the most powerful remaining weapon would be a return to asset purchases, which the Fed undertook in earnest to combat the financial crisis and recession after it had pushed overnight rates close to zero in December 2008. However, support for such a step does not yet seem in place.

The Fed's already dominant presence in the mortgage-backed securities market suggests further asset purchases in that arena may not prove so effective, although it could spark some refinancing activity by narrowing the spread between mortgage rates and yields on government debt.

Instead, if the Fed really fears the economy is at risk of stalling, it could announce another round of purchases of longer-term Treasury securities. In earlier purchases, the Fed bought some $300 billion in Treasuries and more than $1.1 trillion in mortgage bonds, more than doubling its balance sheet in the process to around $2.3 trillion.

Analysts at Goldman Sachs say the Fed could eventually decide large-scale asset purchases are needed.

"Later measures would include a ber commitment to keep rates low and/or asset purchases of at least $1 trillion, most likely also in Treasuries," Goldman Sachs economist Jan Hatzius said in a research note.

Another large bond-buying program could open the central bank up to accusations it is monetizing the debt, something Fed officials would be loathe to do.

But if the choice was between this impression and a new recession, the Fed would most likely decide to act.

While some officials feel the central bank has done enough to spur economic activity, others worry about the economy's lack of momentum.

In a study published on Monday, economists at the San Francisco Federal Reserve Bank argued there is a significant chance the economy will again slip into recession over the next two years.

[Source: By Pedro Nicolaci da Costa, Reuters, 10Aug10]

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