UPDATE 2-Fed officials see need to replace 'Twist' in 2013

Wed Nov 14, 2012 5:07pm EST

Related Topics

* Fed discussed replacing Operation Twist with bond buying

* Twist ends at year end; Wall Street sees more bond buying

* "Thresholds" could help Fed, but more work needed -minutes

By Alister Bull

WASHINGTON, Nov 14 (Reuters) - A number of Federal Reserve officials in October felt the U.S. central bank would need to step up asset purchases in 2013 to fill the gap when Operation Twist expires, according to minutes released on Wednesday that hardened expectations the Fed will take such a decision next month.

The minutes of the U.S. central bank's policy meeting last month also showed that officials looked favorably on the idea of adopting unemployment and inflation "thresholds" to guide expectations about when they would eventually raise interest rates, but felt this needed more work.

Under the program dubbed Operation Twist, the Fed has been selling short-term securities to buy $45 billion in longer-term debt every month to push down long-term borrowing costs. The program is slated to expire at year end.

"A number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program in order to achieve a substantial improvement in the labor market," the Fed said in the minutes of the Oct. 23-24 policy meeting.

Wall Street traders had already expected the central bank to replace Operation Twist in 2013, and analysts said the minutes simply provided another reason to expect a decision to do so at the Fed's next meeting, on Dec. 11-12.

"This reference underscores the dovish bias at the Fed, and it reinforces our base-case expectation for the Fed to continue its current Operation Twist Treasury purchase profile beyond December," Millan Mulraine, senior U.S. macro strategist at TD Securities in New York, wrote in a note to clients.

HAWKS NOT SILENT

In addition to Operation Twist, the Fed is purchasing $40 billion in mortgage-backed securities each month in its third and latest round of quantitative easing, dubbed QE3.

Unlike Twist, which swaps short-term debt with long-term debt, QE 3 expands the Fed's balance sheet. Most analysts expect any Twist replacement would do the same.

The Fed has turned to asset purchases and balance sheet management techniques to try to give the U.S. recovery an extra push since its main tool for influencing the economy -- the overnight federal funds rate -- was dropped to near zero in 2008.

With the jobless rate at a lofty 7.9 percent, the Fed has said it would employ its tools until the labor market improves substantially, and it has pledged to keep an easy policy in place even after the recovery gains traction.

Fed Vice Chair on Tuesday delivered a reminder of the central bank's pro-growth tilt, saying that an optimal path for policy indicated rates remaining near zero until early 2016. .

At the Fed's October meeting, the chief of the Richmond Federal Reserve Bank, Jeffrey Lacker, was the only policymaker to vote against the decision to continue with monthly purchases of mortgage-related debt. But the minutes made clear he was not the only official worried about the Fed's aggressive actions.

"Several participants questioned the effectiveness of the current purchases or whether a continuation of them would be warranted if the recent moderate pace of economic recovery were sustained," the minutes said.

THRESHOLDS

The Fed has said it expects to hold rates near zero until at least mid-2015, but several officials have suggested replacing this calendar commitment with a set of economic variables, or thresholds, that would signal when the time to raise rates was drawing near.

"Many participants were of the view that adopting quantitative thresholds could, under the right conditions, help the committee more clearly communicate its thinking about how the likely timing of an eventual increase in the federal funds rate would shift in response to unanticipated changes in economic conditions and the outlook," the Fed said.

However, it said a number of other officials believed a qualitative description of what was driving the Fed's thinking could be even more informative.

Yellen, in her speech on Tuesday, said she strongly supported the idea of coming up with numerical guidelines. While her influential backing showed the seriousness with which the Fed was pursuing the idea, the minutes made plain that more work was needed.

"Participants generally agreed that the (policy) committee would need to resolve a number of practical issues before deciding whether to adopt quantitative thresholds," the minutes said.

Fed Chairman Ben Bernanke told staff to do more work on the proposal.

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