Internal dissent at the Federal Reserve is the clearest sign yet that it will take a major shock to push the U.S. central bank into more costly emergency measures to prop up the world's largest economy.
The Fed moved further into uncharted waters Tuesday, saying short-term interest rates will probably remain near zero for two more years, but the disagreement among its members suggests it will not wade deeper, as investors had hoped.
Painting a bleaker outlook, chairman Ben Bernanke and his colleagues on the Fed's policy-setting panel said they expect to hold their benchmark rate at a historic low near zero until mid-2013.
With the Fed suggesting that the outlook is dimming for the U.S. economy, the divisive debate on the Federal Open Market Committee (FOMC) about appropriate next steps could provide fresh tinder for the crisis of confidence that has plagued global financial markets in recent weeks, despite Tuesday's stock rally.
“There is a very high bar at the Fed for any further stimulus, such that if it were to be forthcoming, you would have to have a really, really sharp erosion in economic and market prospects to change their minds,” said Derek Holt, vice-president of economics at Bank of Nova Scotia.
“I am deeply concerned about the tone of the statement,” he added.
Three out of 10 voting members on the FOMC opposed the landmark timeline for interest rates, prompting observers to suggest that internal bickering at the Fed was now compounding the partisan gridlock that has gripped Washington for months.
The panel did not close the door to further steps, saying it was prepared to move more aggressively if needed.
But noting the dissenters, chief economist Avery Shenfeld of CIBC World Markets said that presumably, “there were even more objections to bringing out one of the larger guns that the Fed could still use.”
In their statement, Fed policy makers said the U.S. economy has grown “considerably slower” than initially expected. The economy grew at an annual rate of just 0.8 per cent in the first six months of the year as high unemployment and an ailing housing market restrained consumer spending.
It now expects “a somewhat slower pace of recovery over coming quarters” as inflation settles. Conceding that “downside risks to the economic outlook have increased,” the Fed now expects to keep its federal funds rate near zero through mid-2013 after first slashing it to that emergency low in December, 2008.
Even if Mr. Bernanke signals his support for a third round of quantitative easing, already being dubbed QE3, at the Jackson Hole annual conference of central bankers later this month, there’s no indication he would garner the necessary support to proceed.
“If they are going to dissent over just something like announcing the earliest date of which the Fed takes the punch bowl away, just imagine what kind of dissent we are going to see if it ever came down to debating the next round of QE3,” said David Rosenberg, chief economist and strategist at Gluskin Sheff.
The first round of quantitative easing, which began during the height of the global financial crisis, was worth $1.8-trillion (U.S.), while last year’s QE2 had a value of $600-billion. Critics have questioned the efficacy of those asset purchases.
As a result, Tuesday’s Fed statement suggests that the probability of another recession is quite high, Mr. Rosenberg said. “It is not even going to be a double dip because we are so far removed from the last recession. ... This is going to be a completely separate recession,” he said.
Others like Sherry Cooper, chief economist at BMO Nesbitt Burns Inc., are much less dour. She argues that lower gasoline and food prices will help prime consumer spending during the second half of this year, especially now that the disruption from the earthquake and tsunami in Japan has dissipated.
Still, she too expressed her shock at the dissenting votes cast Tuesday at the FOMC. “They should give their heads a shake. Interest rates will rally further, but stock markets sure aren't going to like this.”