Fed unlikely to extend QE2, officials say

Reuters News
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Posted: Mar 25, 2011 5:16 PM
Fed unlikely to extend QE2, officials say

By Ann Saphir

CHICAGO (Reuters) - The Federal Reserve is unlikely to extend its bond-buying program with the U.S. economy now on firmer footing, several Fed officials said on Friday, with one inflation hawk saying the Fed will have to raise rates and sell assets in the "not-too-distant future."

Philadelphia Fed Bank President Charles Plosser, the inflation hawk, for the first time detailed his preferred approach to reversing the Fed's easy money policy to prevent future inflation, driving the 10-year U.S. Treasury yield higher on Friday.

The Fed has kept short-term interest rates near zero since December 2008 and has bought more than $2 trillion in long-term securities to push borrowing costs down further and boost recovery from the 2007-2009 recession. At the Fed's most recent policy-setting meeting, policymakers unanimously voted to continue the bond-buying program begun last November which is slated to end in June.

"Following through on that to the tune of $600 billion, like we've said, I think is appropriate," Chicago Fed President Evans told reporters at the regional bank's headquarters. "I personally don't see as many needs for a further amount, as I probably thought last fall."

Evans comments, along with those of Atlanta Fed President Dennis Lockhart who said on Friday that "it's a high bar" for the Fed to do more, suggest the debate at the Fed has moved away from a consideration of further easing.

"Given the pressure, from the hawks on the Federal Open Market Committee, the public, Congress, and foreign officials, I would highly doubt Evans would say something like that if Chairman Ben Bernanke, New York Fed President William Dudley, and Fed Vice Chair Janet Yellen didn't agree with him," said Eric Stein, a fund manager at Eaton Vance in Boston.

Minneapolis Fed President Narayana Kocherlakota told reporters in Marseille on Friday that the U.S. economy would need to worsen "materially" for the bank to consider further bond-buying.

The U.S. economy grew more quickly than previously thought in the fourth quarter of 2010, the Commerce Department said on Friday, but signs of softer consumer and business spending may slow its momentum in early 2011.

COURSE REVERSAL DEBATED

Speaking in New York, Plosser said the economy has gained "significant strength and momentum" since the summer.

"If this forecast is broadly accurate, then monetary policy will have to reverse course in the not-too-distant future and begin to remove the massive amount of accommodation it has supplied to the economy," said Plosser, one of the central bank's biggest inflation hawks.

"Failure to do so in a timely manner could have serious consequences for inflation and economic stability in the future," said Plosser, a voter on the Fed's policy-setting committee this year.

Plosser's preferred exit strategy would see interest rate hikes coupled with asset sales, he said.

"By tying sales to interest rate decisions, it allows the process for selling assets to be conditional on economic outcomes in ways that are familiar to market participants," he said.

Michael Feroli, chief U.S. economist at JPMorgan Chase noted that Plosser's views are often far from the center of the committee. "Noneetheless, in the aftermath of the Treasury decision to sell (mortgage-backed securities), this will only add to the market's sense that the apparently resolved debate about exit sequencing is being re-opened," Feroli wrote in a note to clients.

Evans, who like Plosser has a vote on the policy-setting committee this year, suggested that the Fed would not quickly move to tighten its extraordinarily loose monetary policy, and would likely try to keep its balance sheet steady once active bond-buying stopped.

That would require the Fed to continue to reinvest proceeds of maturing securities in new purchases, as it has been done for some months now.

"It is natural to expect there would be some period of time between when the $600 billion is completed and an assessment in the change of the trajectory," he said. After a period of what could be some months, he said, the Fed could stop reinvestments, a "modest step" toward tightening that probably not be followed quickly by other steps unless the economy was outpacing expectations.

Evans and Plosser both said the earthquake and nuclear crisis in Japan and the rise in oil prices because of turmoil in the Middle East pose a risk to the U.S. recovery -- but said they expected this risk to be small and short-term.

(Reporting by Kristina Cooke, Edith Honan in New York, Ann Saphir in Chicago, Pedro Nicolai da Costa in Ft. Myers, Fla., Philip Blenkinsop in Brussels, Editing by Padraic Cassidy and Andrew Hay)