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Fed keeps its focus on unemployment

  • Article by: JOSHUA ZUMBRUN and JEFF KEARNS
  • January 27, 2013 - 3:43 PM

WASHINGTON - Federal Reserve Chairman Ben Bernanke's unprecedented bond buying pushed the Fed's balance sheet to a record $3 trillion as he shows no sign of softening his effort to bring down 7.8 percent unemployment.

The Fed is purchasing $85 billion of securities every month, using the full force of its balance sheet to stoke the economic recovery. The central bank began $40 billion in monthly purchases of mortgage-backed securities in September and added $45 billion in Treasury securities to that pace this month.

"We're in uncharted territory," said Julia Coronado, chief economist for North America at BNP Paribas SA in New York and a former Fed economist. Even as "the easy money will flow through financial markets and into the real economy at some point and lift us to a better growth trajectory," the United States faces "a lot of risks," she said.

The Fed's total assets climbed by $48 billion in the past week to $3.01 trillion as of Jan. 23, according to a release from the central bank Thursday in Washington. The announcement came as the Standard & Poor's 500 Index closed at the highest level since December 2007.

Fed policymakers have voiced increasing concern that record-low interest rates are overheating markets for assets from farmland to junk bonds, which could heighten risks when they reverse their unprecedented bond purchases.

Yet with unemployment still high almost 3 1/2 years since the economy began its recovery, Fed officials are expected to affirm their accommodation when they meet in Washington to discuss policy next Tuesday and Wednesday.

"You're hard-pressed to find another example in history where the Fed pulled out all the stops to help a recovery along," said Michael Hanson, senior U.S. economist at Bank of America in New York and a former Fed economist. "It's at least as revolutionary as Paul Volcker coming in and saying we're going to hike rates until inflation" declines.

The Fed has a dual mandate from Congress to achieve stable prices and maximum employment. Volcker, Fed chairman from 1979 to 1987, pushed interest rates to as high as 22 percent to rein in annual price acceleration approaching 15 percent. Now Bernanke is focusing Fed policy on the other mandate, aiming to reduce the ranks of the nation's 12.2 million unemployed workers.

Fed officials have said their $85 billion pace of purchases will continue until the labor market improves "substantially." Still, they disagree on how long they should press on with the buying.

The minutes from the Federal Open Market Committee's Dec. 11-12 meeting show participants were "approximately evenly divided" between those who said it would be appropriate to end the purchases around mid-2013 and those who said they should continue beyond that date. A number of policymakers are concerned the size of the Fed's holdings "could complicate the Committee's efforts to eventually withdraw monetary policy accommodation," according to the minutes.

The central bank's balance sheet has provided record windfalls to the U.S. Treasury. The Fed uses interest income from its bond holdings to cover its own expenses and sends the rest to the Treasury. In 2012, that dividend to taxpayers was $88.9 billion.

One risk from a large balance sheet is the possibility that the Fed's interest income could evaporate in coming years as rates rise, according to a paper released last week written by researchers in the Fed's monetary affairs division. The paper studied different scenarios and concluded that the central bank's payments to Treasury "will likely decline for a time, and in some cases fall to zero."

"We're going to boldly go where no central bank has gone before," said Brian Jacobsen, who helps oversee $210 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wis. "So it's full speed ahead."

The central bank's balance sheet is now more than triple its size before the financial crisis. Fed assets stood at $924 billion on Sept. 10, 2008, the week before the bankruptcy of Lehman Brothers Holdings Inc. helped spark a global financial crisis.

The Fed responded to the financial crisis first with emergency credit programs, and then with bond purchases known as QE, or quantitative easing. In the first round of purchases, the Fed bought $1.7 trillion of securities. In a second round of QE, begun in November 2010, the central bank added an additional $600 billion of Treasuries to its holdings.

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