Fed Expected to Leave Interest Rates “Exceptionally” Low

Fed May Recognize Faster Growth, Maintain Low Rates

Bloomberg  –  Aug 12

Federal Reserve policy makers may today acknowledge economic growth will be faster than they anticipated, while committing to keep the benchmark interest- rate target near the lowest level on record.

Central bankers gather in Washington as analysts project 2 percent growth or faster in the second half of 2009 — twice the pace the Fed forecast in June. At stake in today’s statement: delivering a message that the Fed will ensure the recovery is sustained, without stoking inflation expectations.

The need to reinforce the recovery means policy makers will reiterate rates will be kept “exceptionally low” for an “extended period,” analysts said. At the same time, Chairman Ben S. Bernanke and his colleagues will likely consider ending their $300 billion Treasuries-purchase program, an emergency step taken in March to help pull down borrowing costs.

“It’s a delicate period for the Fed,” said Marvin Goodfriend, a former research director at the Richmond Fed and now a professor at the Carnegie Mellon Tepper School of Business in Pittsburgh. “The Fed needs to balance the signals it’s sending in this meeting between concern for inflation risk” and “premature confidence that the recovery has begun.”

The Federal Open Market Committee, which resumed discussions this morning, is scheduled to issue a statement at around 2:15 p.m. after the end of its two-day meeting.

Former Fed officials differed on whether the FOMC will announce today an intention to let the program to buy long-term Treasuries expire as scheduled in September.

Announcement Predicted

Laurence Meyer, vice chairman of St. Louis-based Macroeconomic Advisers LLC and a central bank governor from 1996 until 2002, and Lyle Gramley, senior economic adviser at New York-based Soleil Securities Corp. and also a former governor, predicted an announcement that the program will end.

Lee Hoskins, president of the Cleveland Fed from 1987 until 1991, and former Fed Vice Chairman Alan Blinder, a Princeton University economics professor, said policy makers will probably retain flexibility by delaying a publicly announced decision.

“My feeling is they want to keep all options open and don’t want to close that door yet,” Hoskins said.

The Bank of England surprised traders on Aug. 6 by expanding purchases of U.K. gilts by 40 percent to 175 billion pounds ($288 billion). The Fed announced its plan to buy Treasuries just days after the Bank of England succeeded through its purchases in reducing long-term rates.

Fed policy makers, by announcing they’ll allow the program to expire, would help ease concerns they’re willing to finance the expanding federal budget deficit, Gramley said.

‘Market Fear’

“The main reason for not extending the program to buy longer-term Treasuries is market fear that the Fed is going to monetize the debt,” Gramley said.

The Fed program hasn’t averted a surge in yields on the 10- year benchmark notes. Ten-year yields have climbed to 3.66 percent from 2.53 percent, when the central bank announced its Treasuries-purchase plan on March 18. The average rate for a 30- year mortgage rose last week to 5.22 percent from a record low of 4.78 percent soon after the announcement, according to Freddie Mac.

Policy makers may also discuss whether to extend beyond this year programs to buy as much as $1.25 trillion of mortgage- backed securities and $200 billion of federal agency debt, while reiterating their June statement that they stand ready to deploy “all available tools” to promote a recovery, Meyer said.

Jolt Markets

San Francisco Fed President Janet Yellen and other central bank officials have expressed concern in recent months that falling commercial real estate prices may jolt credit markets and delay a recovery. The deteriorating commercial property market is one of the economy’s “more difficult areas,” Bernanke said in congressional testimony last month.

Tumbling property values have made it difficult for owners of commercial real estate to refinance $165 billion in mortages this year. In June the Fed expanded the Term Asset-Backed Securities Loan Facility to cover commercial mortgage-backed securities. The TALF, scheduled to expire on Dec. 31, is also aimed at reviving the market for securities backed by auto, credit-card and education loans.

Representative Barney Frank, a Massachusetts Democrat and chairman of the House Financial Services Committee, and 40 other House lawmakers urged Bernanke and Treasury Secretary Timothy Geithner in a letter last month to extend the TALF one year.

Bernanke said in July 22 testimony to the Senate Banking Committee that policy makers will prolong the program if they judge financial markets are still “some distance from normal operation.”

Bottom of Cycle

While sustaining its emergency credit programs, the FOMC “will probably say economic conditions have improved since the last meeting and that we’re approaching the bottom of the economic cycle,” said Sung Won Sohn, an economics professor at California State University-Channel Islands in Camarillo, California.

The economy will grow at an annual rate of about 1 percent during the second half of 2009, Bernanke said in a town-hall- style meeting on July 26 organized by PBS television. In one of the clearest signs the worst recession since the 1930s may be ending, the pace of job losses slowed more than forecast last month and the unemployment rate fell for the first time in more than a year.