December 13, 2008 / 2:35 AM / 11 years ago

Money managers brace for unorthodox Fed

NEW YORK (Reuters) - The U.S. Federal Reserve will stretch the boundaries of monetary policy to shore up the economy but a direct purchase of equities is unlikely, money managers told the Reuters Investment Outlook Summit this week.

Federal Reserve Bank Chairman Ben Bernanke is seen through a backdrop of doors as he addresses housing issues at a home ownership and mortgage conference at the Federal Reserve in Washington, December 4, 2008. REUTERS/Jonathan Ernst

The Federal Open Market Committee is widely expected to cut benchmark U.S. interest rates by at least half a percentage point from the current 1 percent at next week’s two-day policy meeting, pushing ever closer to the “zero bound.”

The Fed has been cutting rates since September 2007 and is almost at the end of that road, fueling speculation about what other tools it will employ and how it will communicate its intentions to the market.

“Cutting interest rates is now like pushing on a string. You won’t get much impact,” Mohamed El-Erian, chief executive officer at the giant bond firm PIMCO, based in Newport Beach, California, said at the summit.

“The unorthodox policy is more important. Most people will not be looking at the monetary policy of the Fed next week but what is the Fed willing and able to do on the unorthodox side,” he said.

Most strategists doubted the Fed would lay out a specific plan for alternative policy in the statement released at the end of its meeting on Monday and Tuesday.

Even so, the statement is sure to draw even more attention than usual as a conduit to the Fed’s current thinking.

BETS ON ZERO

Financial markets show a roughly 20-percent bet that the Fed will lower the benchmark federal funds rate to zero in January, kicking off a “ZIRP,” or zero interest rate policy, where alternative policy tools take center stage.

Still, the strategists said the difference between a 0.5 percent target rate and zero, or for that matter the current 1 percent, was almost indistinguishable given that effective rates have been below the official target for several weeks. On Thursday, cash fed funds were trading at 0.0625 percent.

“It doesn’t really matter, other than optics, whether they go to zero percent. Effectively the economy is running at a lower interest rate than the target fed funds rate,” said PIMCO’s El-Erian.

Various Fed officials have acknowledged since late October that some form of “quantitative easing” is under way as rates sink toward zero.

In a speech on December 1, Fed Chairman Ben Bernanke gave the most detail so far on what the Fed might have in mind to support an economy in what many see as the worst downturn since World War Two, and a heavily wounded financial system.

BERNANKE’S BOLD IDEAS

Bernanke said the central bank could buy “substantial quantities” of long-term debt issued by the U.S. Treasury or mortgage agencies to drive down market-set interest rates.

It could also sidestep the clogged banking system to pump money directly into specific markets, Bernanke said.

That comment was “quite a statement coming from a central banker,” El-Erian said, noting that the speech sent a strong signal of the Fed’s “desire to stabilize the triple-A consumer finance segment, auto loans and credit cards.”

Some traders have speculated that the Fed might buy other assets, even equities, to support the economy as zero-bound interest rates limit traditional monetary policy options.

But investors speaking at the Reuters Summit were skeptical. “I don’t think they’d go so far as to buy stocks,” said David Joy, chief market strategist at RiverSource Investments LLC, a unit of Minneapolis-based Ameriprise Financial Inc (AMP.N), adding: “Equities are too volatile.”

Joy said the Fed could also commit to keep rates low for an extended period as a way to push down longer-term bond yields.

The central bank opted for a similar strategy in 2003 as it tried to tamp down the deflation risks with the fed funds rate already at 1 percent. At that time, though, it pledged to keep rates low for a “considerable period.”

Given that the ensuing long stretch of low rates has been blamed for inflating a housing bubble, Fed officials this time may be more inclined to follow the Bank of Japan’s playbook, and adopt conditionality tied specifically to economic conditions, not the passage of time.

In 2001, the BOJ promised to keep its policy rate near zero as long as consumer prices fell.

Bob Doll, global chief investment officer of equities at BlackRock, said deflation, or a broad decline in prices often associated with an extremely weak economy, was currently the top threat to the economy, and he expects the Fed to “do what it takes” to avoid it.

“They have expanded their balance sheet very considerably. They will expand it some more. I think it is more about the speed,” he told the Reuters summit.

However, Doll said the probability of the Fed buying equities was “close to zero.”

“Hopefully they won’t have to go there. The equity market has stopped going down,” he said. “Some of the things the Fed and the Treasury have done maybe are beginning to make a difference.”

(For summit blog: summitnotebook.reuters.com/)

(Visit blogs.reuters.com/mediafile/ for more coverage at the Reuters MediaFile blog)

(To access other stories on Fed policy click on <FED/AHEAD>)

Editing by James Dalgleish

0 : 0
  • narrow-browser-and-phone
  • medium-browser-and-portrait-tablet
  • landscape-tablet
  • medium-wide-browser
  • wide-browser-and-larger
  • medium-browser-and-landscape-tablet
  • medium-wide-browser-and-larger
  • above-phone
  • portrait-tablet-and-above
  • above-portrait-tablet
  • landscape-tablet-and-above
  • landscape-tablet-and-medium-wide-browser
  • portrait-tablet-and-below
  • landscape-tablet-and-below