INSIGHT: Fed balks at easing stimulus, citing weak recovery

19 September 2013 16:21  [Source: ICIS news]

By Joe Kamalick

Anxiety dominates US economic outlookWASHINGTON (ICIS)--The Federal Reserve this week confounded prognosticators, pundits and punters by holding fast to its monetary stimulus policy despite wide expectations that the US central bank would throttle down.

The Fed’s decision to keep pumping money into the US economy was welcomed heartily by US stock markets with record high closes on Wednesday, and the hold-fast ruling was cheered especially by the nation’s housing market where a developing recovery remains spotty at best.

But the central bank’s reluctance to ease back or “taper” its quantitative easing stimulus programme also speaks to Fed concerns over a continuing weak recovery in the broader US economy.

The Fed said on Wednesday that it will continue its long-standing policy of buying $85bn (€63.7bn) worth of Treasury bills and mortgage-backed securities each month until the nation's employment picture improves.

In a keenly awaited decision, the Federal Reserve Board said that while US economic activity has been expanding at a moderate pace, the nation’s unemployment rate remains high and mortgage loan rates have been increasing, posing a risk to the housing recovery.

On the plus side, said the Fed’s rate-setting  federal open market committee (FOMC), household spending and business fixed investment have improved while the housing sector has been strengthening.

“But mortgage rates have risen further and fiscal policy is restraining economic growth,” the Fed statement said.

The central bank said that it expects US economic growth will pick up from its current pace and that the nation’s jobless rate will gradually decline to a point that the Fed deems acceptable - which according to earlier Fed statements means a jobless rate of less than 6.5%, well below the current 7.3% unemployment measure.

The committee said that while the US economy is gradually improving, the Fed has “decided to await more evidence that progress will be sustained before adjusting the pace of its purchases”.

“Accordingly, the committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month,” the Fed statement said.

That decision is in contrast with widely held forecasts among economists and market pundits that the Fed this month would begin to roll back its economic stimulus policy known as quantitative easing (QE).

Taken together, the Fed said, its policy of buying $85bn worth of Treasury bills and mortgage-backed securities each month “should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery”.

In a part of the statement that suggest the Fed will not roll back its accommodative stimulus policy anytime soon, the committee statement added that the Fed “will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labour market has improved substantially”.

In what has become almost a standard declaration, the Fed also said it would continue its long standing rock-bottom federal funds interest rate of 0%-0.25% until the nation’s jobless rate falls below 6.5% - as long as inflationary pressures remain muted.

The Fed’s decision to stand pat on its stimulus programme was not a surprise for David Crowe, chief economist at the National Association of Home Builders (NAHB).

“I expected this because the economy is still uncertain,” he said.

“Some reports are decent, for example housing starts are good, but the employment numbers are not robust,” he said.

The Labor Department employment report for August showed that 169,000 jobs were added in the month and the unemployment rate dropped a tenth of a point to 7.3%. But those job gains were barely more than the 150,000 new jobs needed each month just to accommodate young people entering the workplace, and the jobless rate fell solely because more than 300,000 job-seekers gave up looking and dropped out of the labour force.

That poor showing on the employment front, said Crowe, “was not good news, and I would guess that it was part of the support for the decision the Fed made”.

The Fed, said Crowe, is “holding off until we see a stronger and more consistent signal that the economy is moving forward, and I think that is the right decision - and it’s good for the housing sector”.

Along with widespread speculation that the Fed would begin to back off from its stimulus programme, there were concerns that such a move, however modest, would serve to drive up interest rates, especially in the home mortgage market.

Crowe doesn’t think that mortgage rates would have been significantly or even moderately affected by a modest Fed rollback, but he said that he is nonetheless “pleased with the Fed’s decision”.

“The downside is that the Fed’s decision shows that they don’t think the economy is doing very well,” he added.

Jed Smith, an economist at the National Association of Realtors (NAR), largely agrees.

“Economic results for the growth of the economy have been disappointing in recent months,” Smith said.

“Today’s announcement by the Fed for a continuation of asset purchases confirms the general disappointment in current economic progress - which has been mediocre and below expected trend for some time,” he added.

What economists call trend growth for the US economy means annual expansion of the nation’s gross domestic product (GDP) at a pace of 3% to 3.5%. Current estimates by a variety of economists expect the nation’s 2013 GDP growth will be around 1.9% at best.

Smith said that current economic reports overall are not bad, “it’s just that they are not as good as desired”.

He said that concerns over the federal budget, Washington’s deficits and the looming debt ceiling crisis and related government payments worries “are tending to keep consumer and business confidence from expanding as rapidly as one would expect” in a normal post-recession recovery.

“As these issues are resolved, there should be additional impetus to the economy,” Smith said. That assumes, of course, that the sharply divided Congress and the White House can take collective action to put those worries to rest.

Paul Hodges, chairman of consulting firm International eChem and an ICIS blogger on economics, shares the view that on-going policy uncertainties made the Fed reluctant to throttle back on its bond buying.

“I suspect that the potential problems over the debt ceiling and the budget may well have been a key influence in the decision to postpone tapering,” he said.

“My guess is that Bernanke wants to set the process in motion before he retires in January, but he probably feels that it would be best to wait for a politically quieter time to begin,” Hodges said.

But Hodges also holds that there are deep, fundamental changes in the US that undermine hopes among the Fed governors that the nation’s economy will pick up enough to warrant a stimulus rollback soon.

“We know full well that the bulk of consumption is done by the wealth creator generation of those in the 25-54 age range,” he said, but as US Census data issued earlier this week shows, “there are now more households in the 65-74 age range than in the under 34-range”.

“We are heading to a world where 40% of the US adult population will be in the 55+ age range, compared to only 30% until 2000,” Hodges noted.

“How can GDP growth not be affected by this dramatic and unprecedented aging of the population?”

($1 = €0.75)

Paul Hodges studies key influences shaping the chemical industry in Chemicals and the Economy
Bookmark John Richardson and Malini Hariharan’s Asian Chemical Connections blog

By: Joe Kamalick
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