Fed minutes show some concerns on bond purchases

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Associated Press

Posted on January 3, 2013 at 2:01 PM

Updated Thursday, Jan 3 at 3:33 PM

WASHINGTON (AP) — The Federal Reserve will keep buying bonds indefinitely to try to keep long-term borrowing costs low. It's just not clear how long indefinitely will be.

Minutes of the Fed's last policy meeting show that officials were divided about when to halt the purchases.

Some of the 12 voting members thought the bond purchases would be needed through 2013. Others felt they should be slowed or stopped altogether before year's end. This group worries that the bond buying is keeping rates so low for so long that it could ignite inflation or encourage speculative buying of risky assets.

The Fed last month ended up approving open-ended purchases of $85 billion a month in Treasurys and mortgage bonds to replace an expiring bond-purchase plan and maintain its level of purchases.

The minutes covered the Fed's Dec. 11-12 meeting. In a statement after the meeting, the Fed said it planned to keep a key interest rate at a record low even after unemployment falls close to a normal level — which it said might take three more years.

As long as the outlook for inflation is mild, the Fed said it could keep short-term rates near zero at least until unemployment drops below 6.5 percent. The unemployment rate in November was 7.7 percent. On Friday, the government will release the rate for December.

The statement was approved 11-1. Jeffrey Lacker, president of Federal Reserve Bank of Richmond, objected for the eighth straight time this year. Lacker has said he thinks the job market is being slowed by factors beyond the Fed's control. And he says further bond purchases risk worsening future inflation.

The minutes showed that "several" Fed policymakers thought the bond buying should probably stop well before 2013 ends.

Investors reacted sourly to the release of the minutes. Stock and bond prices fell modestly as concerns arose that the Fed might scale back its economic support for the economy sooner than many expected.

Paul Ashworth, chief economist at Capital Economics, suggested that the economy will remain tepid enough to persuade the Fed to maintain its bond buying.

"We suspect that another year of lackluster economic growth in 2013, coupled with only a modest improvement in the unemployment rate, will convince the Fed to sustain (bond purchases) into 2014," Ashworth said.

The Fed's meeting last month occurred as Congress and the Obama administration were locked in furious negotiations to resolve the fiscal cliff — the steep tax hikes and spending cuts that were to kick in this month without a deal. The minutes said Fed officials saw the uncertainty over the fiscal cliff as a significant threat to the economy.

The deal Congress reached this week avoided the fiscal cliff. It raised taxes on the wealthiest Americans while preserving the Bush-era income tax cuts on income under $400,000 for individuals and under $450,000 for households.

Chairman Ben Bernanke warned at a news conference after last month's meeting that no Fed actions could outweigh the damage that would result if the economy fell off the fiscal cliff. Congress' agreement this week was probably roughly in line with what Fed officials had expected, private economists say. As a result, they expect no changes soon to the Fed's policies. Its federal funds rate, a benchmark for many consumer and business loans, has remained near zero since December 2008.

Critics of bond purchases have raised concerns that keeping interest rates at ultra-low levels for an extended period of time risks distorting financial market decisions. They worry that when the Fed finally begins raising rates, panic selling of stocks and bonds might ensue.

At its next policy meeting, Jan. 29-30, the Fed is also expected to reaffirm its plan to preserve ultra-low rates until unemployment hits 6.5 percent as long as the inflation outlook isn't more than a half percentage point above its 2 percent target.

Bernanke made clear that even after unemployment dips below 6.5 percent, the Fed might decide that it needs to keep stimulating the economy. Other factors will also shape the Fed's policy decisions, he said.

Analysts note that Congress and the administration face a bigger budget showdown within two months, when they must reach an agreement to raise the country's $16.4 trillion borrowing limit. That agreement might result in deep spending cuts.

"Everybody at the Federal Reserve is probably still on very high alert," said Mark Zandi, chief economist at Moody's Analytics. "We are not out of the woods yet. The fiscal brinksmanship is not over."

In forecasts it updated last month, the Fed said it expected the economy to grow between 2.3 percent and 3 percent this year. Bernanke said that estimate assumed that Congress' budget deal would include some tax increases and spending cuts.

The Fed's outlook for economic growth is slightly higher than many private economists expect but is achievable, says Brian Bethune, an economics professor at Gordon College in Massachusetts.

"The Fed is going to keep the pedal to the metal until we get more clarity" on what kinds of spending cuts Congress will adopt, which could slow the economy going forward," Bethune said.

At its December meeting, the Fed also announced that it would buy $85 billion a month in Treasury securities and mortgage-backed securities to try to keep downward pressure on long-term rates. The Fed said it would maintain those purchases until the job market improved substantially.

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