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Divided Fed edges closer to consensus on ending bond buying

The Federal Reserve building is seen in Washington June 19, 2012. REUTERS/Yuri Gripas
The Federal Reserve building is seen in Washington June 19, 2012. REUTERS/Yuri Gripas

By Jonathan Spicer

(Reuters) - Federal Reserve officials appeared on course last month to end their extraordinary bond buying stimulus by year-end, suggesting a weak March jobs report may have taken them by surprise.

Gathering on March 19-20, before the release of the jobs data, Fed officials took an intellectual deep dive into the risks and benefits of their unprecedented policy accommodation, minutes of the meeting released on Wednesday showed.

While they remained sharply divided on how long their bond purchases should last, the minutes nonetheless suggested they were nearing a decision to start winding them down, with "several" policymakers expecting to halt the buying altogether by the end of the year.

The central bank released the minutes five hours earlier than planned on Wednesday because it inadvertently sent the report to congressional aides and trade organizations on Tuesday afternoon. The Fed said it was investigating the lapse, one of its worst in years.

The minutes, which depressed bond prices, revealed an intense discussion and several disagreements among the Fed's 19 policymakers about carrying on with buying $85 billion in Treasury and mortgage bonds per month to stimulate the economy.

Of the 12 officials who have a vote on monetary policy this year, "a few" expected to taper the purchases around midyear and to end them later this year, the minutes showed.

"Several others thought that if the outlook for labor market conditions improved as anticipated, it would probably be appropriate to slow purchases later in the year and to stop them by year-end," the minutes said.

At the meeting, officials also debated how best to eventually return the Fed's balance sheet, now swelled to more than $3 trillion, to a more normal size in the years ahead, with no firm decision made on the so-called exit strategy.

In the end, the Fed decided to continue its quantitative easing program, which is known as QE3 since it is the third such effort to boost economic growth and spur hiring after 2007-2009 recession.

The decision was made in part because tighter fiscal policies could hurt the economic recovery, which before the March jobs report appeared to be gaining traction.

The dollar hit a four-year high against the yen after the minutes were released, while prices sank on 10- and 30-year Treasuries. Stocks rose with the S&P 500 hitting a record.

"These minutes would really be alarming people if we had not had a weak (March) non-farm payroll," said Michael Jones, chief investment officer of Riverfront Investment Group in Richmond, Virginia.

"These minutes seem more strident, there are more voices cautioning about the exit strategy than in prior minutes, and the language is more precise."

EYES ON LABOR MARKET

Investors are anxiously predicting when the Fed will slow or stop its bond buying, which has lifted stocks and bonds.

The Fed has tied the duration of bond buying to a "substantial improvement" in the labor market outlook, and plans to keep interest rates near zero until the unemployment rate drops to 6.5 percent or so.

Joblessness edged down to 7.6 percent last month, but that was because droves of Americans gave up the search for work. Employers hired at their weakest pace in nine months in March, shocking economists and leading some to predict a later-than-expected end to QE3.

Dennis Lockhart, the head of the Atlanta Fed, said on Wednesday the March jobs report was disappointing, but cautioned not to read too much into one month's activity. He added it was perhaps "premature" for the central bank to begin considering a tapering or halting of the purchases.

Frustrated by the slow and erratic recovery, the Fed is looking for economic growth that will lower the unemployment rate from its historically high level. The economy is expected to have rebounded strongly in the first quarter from meager growth late last year.

READY TO TAPER

The minutes emphasized the Fed is ready to taper its purchases based on economic conditions, rather than halt the program as it did in the last few years with QE1 and QE2.

One of the 12 voters on Fed policy, likely Kansas City Fed Bank President Esther George, who dissented at the meeting, wanted to slow the buying immediately, the minutes showed.

Two of those voters said purchases might well continue as is through the end of the year, the minutes said. Were the outlook to deteriorate, "the pace of purchases could be increased."

Of the Fed's full contingent of 19 policymakers, some of whom rotate in and out of voting positions, many said a continued solid improvement in the labor market outlook could prompt them to slow QE3 "at some point over the next several meetings." A few officials expected to continue the program as is "at least until late in the year."

Millan Mulraine at TD Securities said the tone of the minutes was consistent with the "less dovish" message the Fed and Chairman Ben Bernanke delivered on March 20.

"However, given the recent evidence of weakening domestic economic growth momentum, the bias will likely now be for the Fed to push the timing for any asset purchases further into the horizon - relative to the discussions in March," he wrote.

EXIT STRATEGY

Some within the Fed, especially on the hawkish wing, worry the unprecedented bond buying will disrupt markets or feed asset bubbles, stoke future inflation, or lead to political interference if the central bank starts suffering losses on its balance sheet later this decade.

The balance sheet could rise to $4 trillion by year end if QE3 continues apace. While the Fed is transferring large profits to the Treasury now, it may run into the red if it sells these assets when longer-term rates eventually rise.

At the meeting, some officials worried about future asset sales. Several thought a decision not to sell mortgage-backed securities, or to sell them only very slowly, would mitigate financial stability risks and also "damp the decline in remittances to the Treasury at that time," the minutes said.

EARLY RELEASE

The abrupt release of the minutes at 9 a.m. (1300 GMT) on Wednesday instead of the scheduled 2 p.m. rattled investors and raised questions over who might have benefited from an early look at the market-sensitive data.

Though elaborate security measures guard such information, the minutes were sent to more than 100 people just after 2 p.m. on Tuesday. A Fed spokesman said it appeared to be "entirely accidental" and said the central bank will work with market regulators to investigate.

(Reporting by Jonathan Spicer; Additional reporting by Alister Bull in Washington and Pedro da Costa in Stone Mountain, Georgia; Editing by Neil Stempleman)

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