Economists expect the Federal Reserve to add to its stimulus efforts with an expanded bond-buying program Wednesday when it concludes its last policy board meeting of 2012 amid still-slow growth.
With the U.S. economy still sluggish despite two years and hundreds of billions of dollars of quantitative easing (QE) operations, the Federal Open Market Committee is expected to stick to its guns at the end of its two day meeting.
Gathering just before its “Twist” asset-swap operation expires at year-end, signs are that the FOMC will replace it with more outright bond purchases aimed at lowering interest rates to encourage businesses to invest and hire.
With unemployment still stubbornly high, inflation low, and politicians still battling over averting the looming fiscal cliff, the FOMC has all the reason it needs to expand its QE operations.
But by how much depends on just how weak or strong the Fed’s top officials judge economic growth to be.
Data released on Friday showed the unemployment rate fell to 7.7 per cent in November, which while still unhealthy seems to confirm the slow but steady downtrend in the rate.
Some economists say the figure is innately weak – and so justifying more Fed easing – because it has fallen in a large part because of a rise in labor market dropouts, rather than from job creation.
But others argue that, having continued to fall even after the devastating Hurricane Sandy wreaked havoc on the northeast US economy in November, the jobless rate represents a tightening of the labour market, a sign of economic resilience.
How the Fed interprets the data will be clear when it releases its policy conclusions at 12:30 pm (1730 GMT) and its economic forecasts two hours later.
Fed Chairman Ben Bernanke will field questions in a press conference shortly after that.
With its benchmark interest rate already at a bare-bottom 0-0.25 per cent since December, 2008, the Fed’s main policy tool is its bond and mortgage-backed security purchases, through which it has been holding down long-term interest rates.
The cutoff of Operation Twist, which involves swapping about $45-billion a month in short-term assets with long-term ones, will leave the Fed with only its open-ended QE3 bond purchases in place, worth $40-billion a month.
Public comments from a number of individual Fed officials, and the minutes of the last FOMC meeting, show support for expanding those purchases to ensure liquidity remains easy.
A wild card in all this is the Washington battle over the fiscal cliff, the automatic tax hikes and sharp spending cuts that could send the country back into recession if politicians cannot compromise.
With a deadline at the end of the year, the White House and congressional Republicans appeared still far apart on an alternative deficit reduction plan that could avert the cliff.
The Fed’s Beige Book survey of regional economies, compiled to help FOMC members decide their direction, showed widespread worry among businesses over the standoff.
And in late November Bernanke warned that the cliff’s $500-billion crunch on the economy starting from January 1 “would pose a substantial threat to the recovery.”
Asked what the central bank could do, he replied: “I don’t think the Fed has the tools to offset that.”
That aside, economists differ on how much new QE the Fed could add: $45-billion a month to match the value of the Twist swaps, or less if the FOMC sees the economy gaining.
“We see some risk that the new purchase program will be somewhat smaller than the $45-billion per month widely expected,” said Jim O’Sullivan of High Frequency Economics.
“The continued downtrend in the unemployment rate is a key reason we think officials might not fully replace the amount of long-term purchases under operation Twist.”
The dollar has steadily weakened since Monday ahead of the FOMC decision, losing more than one cent to the euro to $1.3036 early Wednesday.
But David Song, a forex markets analyst at Daily FX, was bullish on the greenback.
“It seems as though the central bank is nearing the end of its easing cycle as Chairman Ben Bernanke holds an improved outlook for 2013. In light of the more broad-based recovery in the world’s largest economy, Chairman Bernanke may strike a more neutral tone for monetary policy, and a shift in central bank rhetoric may pave the way for a US dollar rally.”