Fed's Dudley downplays jobs growth, eyes 2013 bond buys

NEW YORK Thu Nov 29, 2012 12:37pm EST

William Dudley, President and CEO of the Federal Reserve Bank of New York, speaks during the Asia Society and Economic Club of New York luncheon, in New York, September 24, 2012. REUTERS/Chip East

William Dudley, President and CEO of the Federal Reserve Bank of New York, speaks during the Asia Society and Economic Club of New York luncheon, in New York, September 24, 2012.

Credit: Reuters/Chip East

NEW YORK (Reuters) - An influential Federal Reserve official on Thursday signaled some support for further asset purchases by the U.S. central bank in the new year, arguing that recent improvements in jobs growth is still not enough to materially change the struggling labor market.

Speaking only two weeks before a key Fed policy meeting, New York Fed President William Dudley said any further purchases of Treasury securities in 2013 should hinge on the outlook for employment and inflation.

He and another monetary policymaker, Richard Fisher from the Dallas Fed, highlighted the problems that U.S. lawmakers are causing for hiring and the economy in general with each day they fail to strike a deal to avoid a pending fiscal crisis.

Though employment has moderately ramped up across the United States in recent months, that pace is probably not sustainable and will almost certainly take a nosedive if the country goes off the $600-billion "fiscal cliff" of automatic tax rises and spending cuts that are set to start in the new year.

"While job growth has picked up some recently, its pace has been insufficient to materially change the labor market picture," Dudley, a permanent voting member of the Fed's monetary policy committee and a close ally of Chairman Ben Bernanke, said at a Pace University forum in New York.

Unemployment - at 7.9 percent last month - remains "unacceptably high" with too many discouraged workers, the policymaker said.

Though on opposite sides of the central bank's philosophical spectrum, both Dudley and Fisher said it was not yet time to tighten monetary policy and warned that the Fed cannot support the fragile U.S. economic recovery alone.

"We at the central bank have been carrying the load and this is a very dangerous predicament," Fisher, a self-described anti-inflation hawk, said during a lecture in Frankfurt. He called for a clearer fiscal outlook from political leaders, and more action to boost employment.

FED'S OPTIONS RUNNING THIN

The Fed meets on December 11-12 to determine whether to extend purchases of both Treasuries and mortgage-backed securities into the new year, to try to lower longer-term rates and boost the U.S. economic recovery after the 2007-2009 recession.

As it stands, the Fed is buying some $85 billion in longer-term bonds per month. Part of that is a program known as Operation Twist, in which the Fed buys $45 billion in longer-term Treasuries and sells the same amount of shorter-term ones.

While Twist expires at year end, most economists expect the Fed to simply ramp up its $40-billion quantitative easing program, dubbed QE3, to make up most if not all of the shortfall in outright purchases.

While the central bank could continue to snap up assets like this for quite some time, Fed policymakers acknowledge that its economic effect is slowly diminishing. Some, like Fisher, warn that it may even cause inflation problems.

As the Fed runs thin on policy options, the U.S. economy has lagged the 2.5 percent gross domestic growth rate needed over several quarters to make substantial headway cutting the jobless rates. GDP growth was 2.7 percent in the third quarter, up from 1.3 percent in the second quarter.

U.S. political leaders, meanwhile, are trying to broker an agreement to avoid the fiscal cliff, which threatens to send the world's biggest economy back into recession.

On Thursday, U.S. Treasury Secretary Timothy Geithner began a round of meetings with congressional leaders from both parties amid signs the market-rattling uncertainty about the outcome of talks could go down to the wire.

Another uncertainty facing both the economy and the Fed is the after-effects of deadly superstorm Sandy, which hit New Jersey, New York and other nearby states in late October.

Dudley, whose Fed bank oversees the hard-hit region, estimated the storm would likely shave 0.25 to 0.5 of a percentage point from fourth-quarter U.S. GDP growth. The rebuilding will continue well into next year, "providing for somewhat stronger growth than otherwise would have been the case," he added.

'STAY THE COURSE'

In September, when it launched QE3, the Fed said the bond-buying would continue until there is a substantial improvement in the labor market outlook.

"I will be assessing the employment and inflation outlook in order to determine whether we should continue Treasury purchases into 2013," Dudley said on Thursday.

The U.S. jobless rate has fallen from 8.3 percent in July, and from 8.9 percent a year ago. The country has had a decent few months of job growth, and added a better-than-expected 171,000 new non-farm jobs last month.

In its Beige Book report on Wednesday, the Fed said the U.S. economy had performed at a "measured" pace in recent weeks and hiring remained modest.

"Monetary policy provides simply the fuel, but the incentive has to come from our fiscal authorities," Fisher said.

"The gas tank is full (with liquidity) and now we have to get someone to ... step on the accelerator to propel the job-creating machine in the United States," he added. "There is a limit to what a monetary authority can do. All we can do is provide liquidity."

The Fed has kept its key interest rate near zero since late 2008, and expects to keep it there for at least another two-and-a-half years. Answering questions from university students, Dudley said the Fed would "absolutely" remove that accommodation when "the time is right."

But he warned that, if the cliff is not addressed, the economic contraction is likely to be larger than normal because interest rates are so low.

Turning to inflation, Dudley said underlying inflation, compensation trends, and longer-term expectations for prices are "fully consistent" with the Fed's 2-percent inflation target.

"Let me reiterate that the Fed will promote maximum employment and price stability to the greatest extent our tools permit, and we will stay the course," Dudley said.

"When we achieve a stronger recovery in the context of price stability, I'll view it as consistent with our goals and not a reason to pull back on our policies prematurely."

(Additional reporting by Eva Kuehnen and Paul Carrel in Frankfurt; Editing by Chizu Nomiyama)

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