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Fed Expected to Keep Twisting, but Will Markets Shout?

Faced with a wide range of signs warning of an economic slowdown, the Federal Reserve is expected to announce Wednesday that it will extend a controversial bond-buying program even though thereu2019s evidence that it isnu2019t always helping the Americans who most need assistance.

Faced with a wide range of signs warning of an economic slowdown, the Federal Reserve is expected to announce Wednesday that it will extend a controversial bond-buying program even though there’s evidence that it isn’t always helping the Americans who most need assistance.

The rate-setting Federal Open Market Committee is expected to leave its benchmark interest rates unchanged but announce the extension of Operation Twist, a $400 billion bond-buying program set to expire at month’s end, which involves swapping U.S. government bonds that had a short maturity for those with a longer maturity.

The idea behind Twist was to drive down the interest rate on long-term bonds, which serve as a reference in the pricing of auto loans, mortgages and other longer-term loans to consumers and business.

Fed governors have been divided over intervening further in the bond markets, not sure that the economy was weak enough to require it. But data that ranges from consumer sentiment to industrial production to hiring now points clearly to a deceleration of growth.

Faced with coming elections and ongoing problems in Europe, the Fed is under pressure to act now, before things get worse and before its actions inadvertently can become part of the political debate ahead of November’s presidential election.

U.S. stocks rallied Wednesday on the expectation of Fed action to spark economic activity. The Dow Jones industrial average closed up 96 points to 12,837, while the S&P 500 rose by 13 points to 1,358. The NASDAQ finished up 34 points to 2,930.

Financial firms were anticipating another shot of economic caffeine from the Fed beyond the Twist extension. The Securities Industry and Financial Markets Association, the lobby for big Wall Street banks, predicted a slowdown to an annualized growth rate of just 2.1 percent this year and next in its midyear economic outlook released Tuesday.

The outlook included a survey of members, which found that 65 percent of the bankers who were interviewed expected the Fed to engage in more quantitative easing. That’s the term for purchasing bonds to drive down interest rates and spur economic activity. The Fed has conducted two rounds – dubbed QE1 and QE2 by investors – and Securities Industry and Financial Markets Association members think a third round is coming sometime between June and September, in part to offset the ill effects of Europe’s debt woes on the U.S. economy.

“I think Europe has had a rather significant impact on the U.S economy. The financial links were totally ignored,” said John Silvia, an economist who presented the association’s midyear outlook.

A year ago, most analysts projected that Europe’s problems wouldn’t spill across the Atlantic. Now three-quarters of the association’s respondents feared that further deterioration of the European situation and uncertainty about the U.S. fiscal cliff – expiring tax cuts and potential across-the-board spending reductions to reduce the government budget deficit – could shave a full percentage point off the U.S. growth rate

Still, the Fed’s bond-buying efforts are controversial because they now account for $2.3 trillion of the assets on the Fed’s $2.8 trillion balance sheet. Some economists fear that they’ll ultimately spark inflation – the rise of prices across the economy – when the economy does get back to a semblance of normalcy.

In fact, the unorthodox action is designed to combat deflation – the fall of prices – by sparking enough activity to create some inflation.

Recent readings of inflation at the consumer, producer and import level seem to justify concerns of deflation if Europe’s debt problems worsen and spark a wider economic downturn.

How much Americans could gain from any further bond buying is unclear. Even with the unusually low lending rates, banks have proved reluctant to lend. To a lesser extent, consumers are reluctant to borrow. Credit is cheap, but only borrowers with pristine credit scores are getting home loans, said Paul Bishop, the vice president of research for the National Association of Realtors.

“We’ve seen that both in the data and anecdotal evidence from our members,” Bishop said. “The problem is not that banks are being cautious, but in many instances way too cautious. The pendulum has swung far too much to one side.”

While dubious of its direct effect on housing, the Realtors group supports the Fed effort to spark growth.

“If they do nothing, that would probably weigh on consumer confidence and the mood of the market. So at the very least, it keeps things moving forward,” Bishop said. “Hopefully if the economy picks up we’ll see lenders . . . willing to do a little more in terms of their underwriting standards.”

Read more here: https://www.mcclatchydc.com/2012/06/19/152943/fed-expected-to-keep-twisting.html#storylink=cpy
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