Federal Reserve maintains bond-buying stimulus in surprise move

Markets cheered as federal open markets committee says US recovery is too fragile to cut back on $85bn-a-month stimulus

US stock markets hit record highs Wednesday as the Federal Reserve surprised investors by announcing that the economic recovery was too fragile to cut back on its massive $85bn-a-month stimulus program.

After a two-day meeting, the federal open market committee (FOMC) said it required "more evidence that progress will be sustained". The news delighted the markets which had sunk ahead of the news on fears that the Fed was preparing to "taper" the so-called quantitative easing (QE) program. Even the threat of a slight reduction in the stimulus spooked the markets in July.

But the news also underlined the precarious state of the wider economy as a row over the US's debt limit threatens a government shutdown. In a press conference Ben Bernanke, Fed chairman, warned that the current row could have "very serious consequences".

Analysts had expected the Fed to announce that it was preparing to trim back QE, a huge bond-buying scheme aimed at keeping interest rates down and encouraging business investment.

Bernanke signalled in July that the scheme would be cut back and that such a move could be announced in September. But the FOMC concluded to leave the scheme intact for now.

The committee said it saw "improvement in economic activity and labor market conditions". But it added: "However, the committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases."

It would continue to closely monitor economic and financial developments in coming months and continue its purchases of Treasury and mortgage-backed securities "until the outlook for the labor market has improved substantially in a context of price stability".

Bernanke warned that the political clash over the US's debt limit and the threat of a government shutdown were all likely to harm the economy. "A government shutdown and failure to raise the debt limit could have very serious consequences for financial markets and the economy," he said.

The FOMC said fiscal policy was "restraining economic growth" and expressed concern about rising mortgage rates and the still high unemployment rate. Bernanke said the FOMC's ability to mitigate the impact of a debt ceiling crisis was "very limited".

Bernanke has linked any tapering of the QE policy to a sustained decline in the unemployment rate. US unemployment dipped to 7.3% last month, down from 8.1% a year ago. But the pace of job recovery remains sluggish and the latest drop was driven in part by people deciding to leave the workforce. The labour force participation rate slumped to 63.2%, its worst reading in 35 years.

Only one member of the FOMC, Esther George, chief executive of the Federal Reserve Bank of Kansas City, voted against the decision not to cut back on QE. She has been a persistent critic of the scheme. According to the Fed, George "was concerned that the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations".

US stock markets soared to record highs shortly after its release. Both the Dow Jones and S&P 500 set new records after the news. The Dow closed up over 147 points at 15676.94, the 31st time this year it has set a new record. Oil and gold prices also rose. The yields for the benchmark 10-year Treasury note sunk and the dollar slumped to a seven month low against the euro.

President Barack Obama is now assessing potential successors and Bernanke's second term ends in January. On Sunday former Treasury secretary Larry Summers withdrew from the race leaving vice-chairman Janet Yellen seen as most likely to succeed to the post. Bernanke declined to comment on the succession. "I'd prefer not to talk about my plans at this point," he said.

The Fed's move comes as the US faces a potentially disastrous row over increasing its borrowing limits. In 2011 a standoff in Congress over the debt ceiling led to a historic downgrade of US debt and panic on the financial markets.

Obama accused Republicans of trying to "extort" him Tuesday by holding up negotiations unless he is prepared to amend or scarp his landmark healthcare reforms, the Affordable Care Act. Republican House speaker John Boehner hit back Wednesday calling Obamacare "a train wreck", as other party leaders set out further terms and conditions for raising the limit. The two sides are now at an impasse just days before the 30 September deadline to pass a government funding bill.

The government reached its $16.7tn debt limit in May and has been employing emergency measures to manage its cash, such as suspending investments in pension funds for federal workers, to stay below the line. But Treasury secretary Jack Lew has warned that the government will run out of room to manoeuvre in October and will be unable to meet its obligations.

On Tuesday Lew warned Congress again that a prolonged argument over the debt limit could do lead the US to default on its debts and irrevocably damage to the economy. "We cannot afford for Congress to gamble with the full faith and credit of the United States," Lew told the Economic Club of Washington.

A default would likely cause turmoil on world stock markets and a sharp rise in interest rates. Lew repeated a warning he made last month that the Treasury would soon be left with only around $50bn in cash on hand. The Treasury pays investors about $100bn to investors every Thursday that investors immediately lend back to the government, a process known as rolling over the debt.

"If US bondholders decided that they wanted to be repaid rather than continuing to roll over their investments, we could unexpectedly dissipate our entire cash balance," Lew said.

Default could come soon after that and would likely rock Wall Street and lead to a sharp rise in interest rates.

Article Source : http://www.guardian.co.uk

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Federal Reserve begins two-day meeting as stimulus taper looms

Speculation mounting that chairman Ben Bernanke is preparing to announce cuts on economic stimulus programme

The Federal Reserve began a two-day meeting Tuesday as speculation mounted that chairman Ben Bernanke is preparing to announce cut-backs on the US's $85bn-a-month economic stimulus programme.

Bernanke will hold a press conference Wednesday to discuss the Fed's plans. The event comes amid speculation that he will announce his resignation: Bernanke has made clear he will not seek a third term as chairman and Barack Obama is now assessing replacements.

The Fed's third round of bond buying, known as quantitative easing, was announced last September and has so far pumped about $800bn into the bond markets in an attempt to kick-start investment and keep interest rates down. In June, Bernanke announced some "tapering" of policy could begin later this year if the economy continued to improve.

The Federal Reserve's open markets committee (FOMC), however, is split on QE with some concerned about the unintended consequences of the massive programme. In previous FOMC meetings some members have made clear they want an early end to the programme.

On Monday, stock markets reacted positively to news that former Treasury secretary Larry Summers had withdrawn from the race to succeed Bernanke. Janet Yellen, the Fed's vice-chairman, is now seen as the most likely successor. Summers was seen as being more critical of QE while Yellen has backed Bernanke in his support of the programme on the FOMC.

Paul Dales, senior US economist at Capital Economics, said the Fed was likely to announce some tapering of QE. "It will be a close call but I think it's more likely than not," he said. "It will depend on whether the Fed believes the labour market has improved enough in the last months, and for the right reasons."

Last month the US unemployment rate dropped to 7.3%, down from 8.1% a year ago. But the pace of job recovery remains slow and part of the drop was due to people leaving the workforce. The labour force participation rate slumped to 63.2%, its worst reading in 35 years.

Dales said it was clear that some members of the committee were becoming increasingly alarmed by the scale of the QE programme. "They are not too sure what the costs are," he said. "Perhaps further asset bubbles or destabilizing the financial markets. They have never done before."

Bernanke has ducked questions about his future at previous press conferences. He will not hold another scheduled FOMC press conference until December. His term is due to expire at the end of January. Despite the tight timetable economists expect him once more to focus on economic policy rather than his future and the appointment of a successor.

Article Source : http://www.guardian.co.uk

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US economy expands at stronger rate in second quarter, figures show

Rate of GDP growth more than double the pace clocked in prior three months and stronger than the 2.2% economists forecast

The US economy expanded at a stronger rate in the second quarter than previously estimated, according to figures released on Thursday.

After a boost to figures for exports and business investments, the Commerce Department revised its measure of the nation's gross domestic product (GDP), the broadest measure of goods and services produced in the economy, to an annual rate of 2.5% in the second quarter, up from an initial estimate of 1.7% reported last month.

The rate of growth was more than double the pace clocked in the prior three months and stronger than the 2.2% that economists polled by Reuters had forecast.

US stock markets reacted positively to the news, which was released as the Labor Department reported another slide in the number of people claiming unemployment benefits for the first time. Initial claims for state unemployment benefits slipped 6,000 to a seasonally adjusted 331,000 for the week ending 24 August, the Labor Department said.

The report comes as the Federal Reserve appears close to cutting back on its $85bn a month bond-buying stimulus programme, known as quantitative easing. Federal Reserve chairman Ben Bernanke has indicated that the programme could be scaled back as early as later this year but has as yet not specified a date.

Bernanke has tied a cut in QE to the unemployment rate. Next Friday the US releases its monthly tally of employment figures, the non-farm payroll report. The continued fall in initial claims helped push the unemployment rate to 7.4% last month, its lowest level since late 2008.

However, economists warned that problems remained in the US economy and the revision in GDP also highlighted some of those weaknesses. Consumer spending remained unchanged in the quarter and state and local government spending fell in the quarter as compared to being up in the initial estimate.

Gus Faucher, senior economist at PNC Financial Services, said the rise was good news. "But it's still a 1.6% rise year over year, and that's soft. We are still down 2m jobs and we are seeing significant drag from tax increases and spending cuts."

Faucher said growth should pick up in the second half of 2013 and into 2014. "Consumers are adjusting to higher taxes. Business investment will continue to improve as profits are at a record high and borrowing costs are still very low, despite the recent increase in rates," he said.

Dan Greenhaus, chief global strategist with broker BTIG said: "With the revisions, our original estimate calling for 1.5% growth in the first half was a bit under what has actually occurred. That's a positive but of course what matters now is not what has happened but what will happen. In that regard, the consensus still expects roughly 2.5% growth in the second half but that may prove to be too optimistic."

The GDP figures come amid a looming clash in Washington over the "debt ceiling" – the limit set by Congress on the US's ability to borrow. Treasury secretary Jack Lew warned earlier this week that if Congress fails to act soon, the US would hit its debt limit by mid-October.

Failure to reach a new agreement would risk "irreparable harm" to the US economy and leave the government struggling to make the 80m payments a month it sends out, including military salaries and social security cheques, he said.

Faucher said failure to raise the debt ceiling would be "disastrous – worse than a government shutdown." But he said ultimately he expected Congress would act to see off the crisis.

Article Source : http://www.guardian.co.uk

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US to relax quantitative easing but emerging markets grow tense

As the US Federal Reserve tapers QE and interest rates rise, there are reasons not to fear a repeat of the Asian crisis

Brazil last week became the latest country to take emergency action to shore up its currency as anxious investors piled out of emerging markets. India, Indonesia, Turkey: there was more than a whiff of panic in the air as policymakers tried to reassure financial markets they remain a good bet.

The Brazilian real has lost 20% of its value against the dollar since the start of the year, the rupee is down 15% and the Turkish lira down 10%. The situation has alarming echoes of the catastrophic Asian financial crisis of 1997-98. Back then, Thailand became the first of the fast-growing "Asian tigers" forced to turn to the International Monetary Fund (IMF), as foreign investors lost heart and left and its currency plunged, sparking a chain reaction that spread across much of the continent.

This time the looming crisis has been caused by a change of heart by the Federal Reserve, thousands of miles away in Washington. In 1997, it was Alan Greenspan's decision to push up US interest rates that sparked investors to pull their cash out of riskier markets to take advantage of better returns back home. This time, it's the stated intention of Ben Bernanke, the chairman of the Fed's board of governors, to start"tapering" its unprecedented $85bn a month programme of quantitative easing (QE), perhaps as soon as next month.

Under QE, the Federal Reserve hoovers up assets, mainly US government bonds or US treasury notes in a bid to push up their prices, which helps to reduce interest rates across the economy and create the conditions for recovery. But a side-effect of the policy is that banks and other investors use the cheap cash to go on a global shopping spree, looking for tempting investment prospects from Rio de Janeiro to Jakarta.

When the money is flooding in, inflating share prices and driving down the cost of government borrowing, it's easy for politicians in emerging economies to believe their own hype - political stability, the rising middle class, a large and growing workforce, huge untapped potential. But when the tide turns, they can suddenly become acutely vulnerable.

There are several reasons to be optimistic that we're not heading for a repeat of the Asian crisis. Many of the countries involved have piled up vast stockpiles of foreign currency reserves in the past 15 years in a deliberate bid to avoid being forced into the hands of the IMF. Few are reliant on the foreign-currency denominated loans that were a particular problem back then, and the Federal Reserve is acutely aware of the risk of sparking a new global financial crisis.

But while Central bankers have always known that the scale of the so-called "unconventional measures" that they unleashed on the world since the Great Crash of 1929 was unprecedented, they have no idea what the consequences will be as they start to unwind them. Just about every country that's been wooed by Wall Street over the past five years has good reason to be afraid.

Article Source : http://www.guardian.co.uk

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