Posted on 09 Aug 2010
Friday's report that showed new jobs fell short of projected numbers has many wondering whether the Federal Reserve will make a move this week intended to deliver a boost to the wavering U.S. economic recovery.
The Fed's most dramatic move would be to purchase new mortgage-backed securities or Treasury bonds to lower interest rates, but such an initiative is staunchly opposed by inflation hawks on the Federal Open Markets Committee.
Far more likely, many economists say, is that the central bank will take a middle-ground, largely symbolic approach at its meeting Tuesday and prevent its vast holdings of securities from shrinking, to keep interest rates from rising slightly.
Debate about how the Fed might goose a lackluster rebound was already swirling when the Labor Department reported Friday that the private sector added just 71,000 jobs in July, fewer than the 90,000 expected. Even more worrisome, employers cut 6,000 temporary workers after adding 385,000 since September. Temporary staff additions typically herald more permanent hires.
Although the report was discouraging, it wasn't dismal, and policymakers could stand pat. But Paul Ashworth of Capital Economics says, "Clearly, now everybody is looking for the Fed to do something."
During the financial crisis, the Fed pushed down short-term interest rates to near zero and then took the extraordinary step of purchasing about $1.7 trillion in mortgage securities and Treasuries. That further drove down mortgage rates a half-point and helped stimulate the housing market.
But those purchases ended earlier this year and the Fed has allowed its mortgage portfolio to shrink slightly to $1.1 trillion as homeowners pay off, or refinance, their loans. By contrast, the Fed has reinvested maturing Treasury bonds in similar assets.
The central bank now could purchase new mortgage securities or Treasury bonds to further lower borrowing costs. Chris Rupkey of Bank of Tokyo says that will be considered, with some policymakers "having lost patience" with the slow recovery.
But it will be anathema to the handful of policymakers who want the Fed to start selling assets to head off inflation. At its June meeting, the Fed said it would make such a move only if the economic outlook worsened "appreciably."
Economists say the better bet is the Fed could agree to reinvest the proceeds from maturing mortgage securities in new mortgage or Treasury assets. Ashworth says Treasury purchases are more likely because they would spread the benefits beyond the housing sector and Treasury bonds would be easier to sell. Yet, he says, only about $150 billion in mortgage assets are maturing each year, so the effect on interest rates would be minuscule.
"The only thing it would do is reassure jittery financial markets that like to see action," he says.
Still, economist Nigel Gault of IHS Global Insight says the strategy would signal the Fed is prepared to resume asset purchases if the economy weakens further. That alone, he says, could push down rates.