Wall St debates possible election influence on Fed stimulus

NEW YORK Sun May 13, 2012 8:59am EDT

Related Topics

NEW YORK May 13 (Reuters) - The Federal Reserve has propped up the U.S. economy several times since the financial crisis struck, but many on Wall Street think the approach of November's elections may make it hesitate to do it again.

Investors are weighing up the chances of more stimulus after recent signs the recovery is flagging. Chairman Ben Bernanke has said the Fed would take action if needed.

Still, with elections six months away and the Fed a regular target of conservative candidates, some economists think the central bank could be influenced by political considerations.

The Fed has over time established an arms-length relationship with incumbent administrations to insulate itself from short-term political pressures.

To be sure, most reckon the Fed would respond quickly to a new emergency such as a sharp deterioration of Europe's debt crisis. The question is whether it would hesitate in the face of a less dramatic problem, such as a weakening labor market.

After two rounds of bond buying, the Fed has bought a total of $2.3 trillion of Treasuries and mortgage-backed securities to help keep interest rates low and encourage economic activity.

"The consensus seems to be pretty divided on this," said Aneta Markowska, economist at Societe Generale. "Our take is if they do something, they have to do it relatively quickly. We would need to see a more meaningful deceleration in activity for them to initiate something the closer we get to the election."

Brett Ryan, economist at Deutsche Bank, dismisses such talk, saying the Fed will stringently adhere to its dual mandate. "The trajectory of the labor market and inflation will tip the balance in its decision making, regardless of timing around a presidential election," he said.

A Reuters poll of the large financial institutions that do business directly with the Fed showed how split market experts are about any election effect.

Eight of 15 economists at primary dealers said the central bank would not be at all swayed by worries about politics if it came to undertaking more stimulus.

But economists at seven others said the Fed might hold off on another round of debt purchases even if the economy continues to have sub-par growth and unemployment remains high.

There are a total of 21 U.S. primary dealers.

The Fed has four more policy meetings before November. Some economists see the window of opportunity for more stimulus narrowing after the next gathering, June 19-20.

"That is the perception on Wall Street, that the window for action closes with the June meeting," said Michael Feroli, chief U.S. economist, at JPMorgan.

The Fed's current stimulus program, "Operation Twist," extends the maturity of the Fed's securities holdings to lower long-term interest rates such as those on mortgages. It is due to last through June.

"If the outlook worsens sufficiently ... I don't think politics would keep the Fed from easing," said Benjamin Reitzes, senior economist at BMO Capital Markets.

"However, if the decision to ease is a marginal one, the fact that it's an election year could keep them sidelined a little longer than otherwise," he said.

Michael Hanson, economist at Bank of America Merrill Lynch, said the Fed has tended not to relax monetary conditions close to presidential elections.

President George H.W. Bush was disappointed that then-Fed Chairman Alan Greenspan did not cut interest rates more aggressively in the lead-up to the 1992 elections. Bush lost the presidency to Bill Clinton.

"I reappointed him and he disappointed me," Bush said of Greenspan in an interview aired in 1998.

Bernanke's Fed announced its second round of bond-buying - $600 billion of longer-term Treasuries - on Nov. 3, 2010, one day after midterm elections.

The move came as no surprise, however, as Fed officials, including Bernanke, had signaled the Fed was prepared to go ahead with more measures to help growth.

Jacob Oubina, senior U.S. economist at RBC Capital Markets, said the Fed probably did not take the midterms into account then. "But now everybody is talking about it, if they will influence the election by engaging or not engaging in a QE3 program," he said.

The bar for any new Fed program looks high. The U.S. economy has shown signs of recovery, albeit an anemic one, and some Fed officials are adamant there is no need for further stimulus.

Also, political pressure on the Fed has rarely been higher as Republicans and Democrats spar over the best way to kick-start economic growth and reduce unemployment and huge budget deficits, said Allan Meltzer, a Fed historian and professor at Carnegie Mellon University.

"There have been some exceptions, but they are usually very careful to try not to be accused of taking action for political reasons, and especially now when Republicans in Congress are on their back, they are pretty conscious of that risk," he said.

Alice Rivlin, who was Vice Chairman at the Fed when Democrat Bill Clinton ran as the presidential incumbent and won i n 1996, said as a general practice there is no consideration by central bank officials of politics.

"I think the Fed is aware it is an election year obviously, but would not pay much attention. If anything they would lean over backwards not to do anything which could be interpreted as playing a role in the election," sh e said.

FILED UNDER:
A couple walks along the rough surf during sunset at Oahu's North Shore, December 26, 2013. REUTERS/Kevin Lamarque

Find your dream retirement town

Florida? Hawaii? Reuters has teamed up with Zillow to give you the power to customize a list of your best places to retire.  Video | Full Article