The Federal Reserve's decision last month to maintain the size of its economic stimulus was a shocker. Just about everyone expected a pullback in its bond purchases, which have helped keep loan rates low.
The Federal Reserve’s decision last month to maintain the size of its economic stimulus was a shocker. Just about everyone expected a pullback in its bond purchases, which have helped keep loan rates low.
Thanks to the government’s partial shutdown, many analysts don’t think the Fed will reduce its stimulus before next year. And with the White House’s choice of the like-minded Janet Yellen to succeed Ben Bernanke as chairman next year, the Fed will likely be cautious about any pullback in early 2014.
Bernanke and the Fed may also now look a bit wiser to those who questioned their stance last month. After all, a key reason Bernanke gave for maintaining the pace of the Fed’s stimulus was Washington’s budget impasse. It posed a risk to the economy and financial markets, he suggested.
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Bernanke said the budget standoff would likely make it harder to know whether the economy was strong enough for the Fed to slow its stimulus.
If anything, the economic outlook is getting darker: Even if the partial shutdown ended now, a graver threat awaits: A deadline to raise the federal borrowing limit. If Congress doesn’t raise the limit by Oct. 17, the government would soon run out of cash to pay interest on its debt. Any missed payment would cause a default. Another recession would likely follow.
In hindsight, many economists think the Fed would have erred if it reduced its stimulus last month.
It almost did.
Some Fed officials have said the policy committee’s decision at the Sept. 17-18 meeting against paring the $85 billion in monthly bond purchases was a close call.
Still, one voting member of the committee, James Bullard, head of the St. Louis Federal Reserve Bank, noted that Fed officials have stressed that any pullback in bond purchases would hinge on the strength of the economy. Some data released before the Fed’s September meeting had showed a weakening economy, Bullard noted.
On Wednesday, details about last month’s decision could emerge when the Fed issues the minutes of the September meeting. The minutes will likely show concern that the economy wasn’t growing as fast as the Fed had forecast and that some indicators, such as job growth and consumer spending, had weakened.
Even after the Fed chose last month not to slow its stimulus, some analysts said it might reduce the bond purchases at its next meeting Oct. 29-30 or at the final meeting of the year, Dec. 17-18.
Few are saying so anymore. What’s changed was the partial shutdown, which many analysts hoped would be averted, and the growing risk that Congress won’t raise the debt limit and will cause the government to default.
Now, many economists say they think the Fed will leave its support at the current high level into 2014.
“With everything that is happening with the federal budget, the Fed is going to be even more cautious about doing anything,” predicted Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University. “The best approach they can take right now is stand pat and watch.”
For one thing, the outlook for the economy will remain murky as long as the partial shutdown goes on. The shutdown has delayed the government’s release of critical economic data. The jobs report for September, for example, was due out Oct. 4 but has yet to be released.
In the meantime, the Fed will need to monitor the economic effects of both the shutdown and the possibility of a government default.
Treasury Secretary Jacob Lew has told Congress that he likely will have exhausted all the book-keeping maneuvers he can use by Thursday of next week. By then, the government will have only about $30 billion cash on hand.
Lew has urged Congress to raise the current $16.7 trillion borrowing limit before then. President Barack Obama has repeatedly said he won’t negotiate with Republicans over raising the debt limit as he did during a previous such fight in August 2011.
The 2011 standoff was resolved at the last minute. The borrowing limit was raised before the government defaulted on its debt obligations. But the prolonged political impasse led Standard & Poor’s to downgrade long-term U.S. debt for the first time in history.
Most analysts also expect the current debt-limit standoff to be resolved before the deadline given the economic crisis that would ensue if it isn’t.
But Mark Zandi, chief economist at Moody’s Analytics, said it could take the threat of further turbulence in financial markets to break the logjam.
“I think the most likely scenario is that policymakers only act when financial markets begin to sell off,” Zandi said. “It will require lower stock prices, a lower dollar and turmoil in the bond market to get Washington to move.”
Zandi is among those who think market turmoil will delay any pullback in the Fed’s bond purchases. He foresees no slowdown in the purchases until 2014.
“With each day that the lawmakers can’t get it together, the economic damage mounts, and the day the Fed starts tapering is pushed off,” he said.
It’s always possible that Congress could act faster than some expect to resolve the shutdown and the government’s borrowing limit. If so, some say the Fed might still act before year’s end to scale back its stimulus.
But Vincent Reinhart, chief economist at Morgan Stanley and a former top economist at the Fed, said he saw the likelihood of a cut in bond purchases as around 5 percent at the Fed’s October meeting and 10 percent at the December meeting.
Sohn said the Fed’s meeting in March could be the first one when it might feel the economy was strong enough to withstand a pullback in bond purchases.
If the slowdown in bond buying began in March, it would be a full six months after the September date where many had initially expected the Fed’s pullback to begin.
That’s why Sohn thinks the mid-2014 point that Bernanke had mentioned as a likely time for the bond purchases to end will likely slip until the end of 2014.
Sohn said he expects the Fed to eventually take small steps in cutting its $85 billion in monthly purchases, possibly in reductions of $10 billion to $20 billion that would end in December 2014.
“The Fed wants to take measured steps, and I don’t think they will move until Yellen feels she is in firm command,” Sohn said. “Washington’s budget craziness has made the Fed more cautious.”