Fed May Signal U.S. Economic Recovery Has Started

Fed May Signal U.S. Economic Recovery Has Started

Sept. 23 (Bloomberg) -- Federal Reserve officials may signal that the U.S. economy has started to recover while maintaining their pledge to keep the benchmark interest rate near a record low for an “extended period.”

Policy makers meet as analysts project 2.9 percent growth in the quarter ending this month, compared with a 1 percent estimate in July. Officials will probably debate their purchases of $1.45 trillion in housing debt, including whether to extend the emergency program into 2010, analysts said.

Chairman Ben S. Bernanke and his colleagues may seek to contain any investor expectations that they will begin raising interest rates as soon as this year by citing risks to the economic recovery. Today’s Fed statement may retain references from last month to rising unemployment and “tight” credit as constraints on consumer spending.

“The Fed has to strike a delicate balance by saying that while economic prospects have brightened, the Fed will continue to provide a helping hand to ensure a bottom to markets and a durable recovery,” said Wan-Chong Kung, who helps oversee $85 billion in investments at U.S. Bancorp’s FAF Advisors in Minneapolis.

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

Signs of a recovery include a stabilization in the housing industry and gains in exports, retail sales and industrial production, said Mark Gertler, a professor of economics at New York University.

‘Very Early Stage’

“The bottom is no longer falling out, but the recovery is still at a very early stage,” said Gertler, who worked with research on the Great Depression with Bernanke before he became Fed chairman. “There is no need to expand the balance sheet now, but it is a bit too early to begin shrinking it.”

The Fed has kept the benchmark lending rate at a range from zero to 0.25 percent since December and has adopted asset purchases as its main policy tool. In its August statement, the FOMC said “exceptionally low” rates are likely warranted for “an extended period.”

Central bank officials may also discuss changing the size and duration of their plan to buy as much as $1.25 trillion of mortgage-backed securities and $200 billion of agency debt by the end of this year, said former Fed governor Laurence Meyer, now vice chairman of St. Louis-based Macroeconomic Advisers LLC.

Three district bank presidents -- Jeffrey Lacker of Richmond, James Bullard of St. Louis and Dennis Lockhart of Atlanta -- raised the possibility that the Fed may not spend all the money authorized for the mortgage-backed debt. New York Fed President William Dudley, by contrast, stressed an exit would be “premature,” citing high unemployment and weak growth.

Repurchase Agreements

Fed officials have started talks with bond dealers to use so-called reverse repurchase agreements to drain some of the cash the central bank has pumped into the economy, according to people with knowledge of the discussions. There’s no sense that policy makers intend to withdraw funds anytime soon, said the people, who decline to be identified.

Bernanke said last week the worst U.S. contraction since the 1930s has probably ended, while warning that unemployment will be “slow to come down.”

“Even though from a technical perspective the recession is very likely over at this point, it’s still going to feel like a very weak economy for some time,” Bernanke said Sept. 15 following a speech in Washington.

Case for an Increase

A return to growth may bolster the case for an increase in the Fed’s target rate, Stanford University economist John Taylor said in a Sept. 11 Bloomberg Radio interview.

The Fed may need to raise the rate in the first half of 2010 should inflation increase, said Taylor, who devised a guideline for setting the target interest rate based on growth and inflation.

Most FOMC officials are worried expectations for a higher federal funds rate will push up yields on 10-year Treasury notes, increasing mortgage costs, said Michael Feroli, an economist at JPMorgan Chase & Co. in New York and a former member of the Fed’s research staff.

“Probably two thirds of the committee is concerned that being too quick to embrace the stronger growth story could lead the market to price in sooner rate hikes and tighter financial conditions than they would like,” he said.

The yield on the 10-year Treasury note fell to 3.45 percent yesterday from 3.72 percent on Aug. 12, the day of the last FOMC announcement.

‘Additional Comfort’

That “provides the committee with additional comfort that inflation expectations will remain well anchored,” Meyer said.

The decline in bond yields has been partly driven by comments by Bernanke and other policy makers during the past month indicating the economy, while improving, remains weak. San Francisco Fed President Janet Yellen predicted a “tepid” recovery, while Lockhart cited a “lackluster outlook.”

Unemployment is forecast to reach 9.8 to 10.1 in the fourth quarter, according to policy makers’ forecasts in June. The jobless rate rose last month to 9.7 percent, the highest since 1983.

“Clearly, they need to remain more than humble when declaring victory in an economy that still faces headwinds,” said Diane Swonk, chief economist at Mesirow Financial Inc. in Chicago. Chief among the risks is “ongoing credit tightness, most notably in the commercial real-estate sector,” she said.

Property Values

Falling property values have impeded efforts by owners of commercial real estate to refinance $165 billion in mortgages this year. Also, total bank credit to the economy grew just 2 percent in August compared with the same month last year, according to Fed data.

The central bank is likely to repeat its view that inflation will remain “subdued for some time” because of slack in the economy, analysts said. Consumer prices fell 1.5 percent in the year ended in August.

“The Fed must keep an eye glued to whether inflation expectations have become unanchored,” said former Fed Governor Lyle Gramley. “As long as the dramatic moderation in wages persists, you don’t have to worry about inflation,” said Gramley, senior adviser to New York-based Soleil Securities.

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