Fed Is Expected to Keep Rates And Asset Purchases on Hold

The Federal Reserve began a two-day meeting on Tuesday at which it is expected to dampen expectations for interest rate hikes this year, while holding steady on its plans for asset purchases.

AP Federal Reserve Bank Chairman Ben Bernanke

A Fed official said the meeting got underway at around 1 p.m. New York time. A statement announcing the policy decision is expected at about 2:15 p.m. on Wednesday.

Economists widely expect the U.S. central bank to hold its target for the federal funds rate, the rate banks charge each other for overnight loans, in the zero to 0.25 percent range reached in December.

The Fed is also not expected to ramp up asset purchases above an existing promise to buy $300 billion of longer-dated U.S. government bonds and $1.45 trillion of mortgage debt.

It may, however, stretch out its buying of U.S. Treasury debt to last until year-end, or divert cash now earmarked for mortgage-related debt to government bonds.

Goldman Sachs' economists expect the Fed to slow its purchases of longer-dated U.S. Treasuries to $5 billion a week from a current average around $13 billion to make the program last for the rest of the year.

One reason it may stop short of ramping up the actual amount of Treasurys it plans to purchase is worry among some policy-makers about inflation.

Fed officials are sensitive to accusations that it is 'monetizing' U.S. debt by printing money to purchase government bonds, which critics claim could lead to a problematic outbreak of inflation. It is a charge Fed Chairman Ben Bernanke has denied.

"An unchanged $300 billion program would make it easier to maintain this position because it would keep the Fed's total holdings of Treasurys just below pre-crisis levels,'' Goldman Sachs wrote in a note to clients.

The Fed subsequently ran down these holdings as it sold billions of dollars of Treasurys last year to sterilize the balance-sheet impact of other asset purchases it made to ease credit markets in the middle of a financial panic.

But the Fed is expected to push back against speculation that it will raise rates before the end of the year, and economists were focused on how the language of its policy statement could be tweaked to accomplish this tricky mission.

Interest rate futures markets had priced in a hike in the federal funds rate to 0.5 percent by year-end, which accompanied rising yields on longer-term U.S. Treasurys that pushed mortgage rates higher, but this view has softened somewhat in the last week.

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Still, markets continue to give a 38 percent likelihood the fed funds rate will be 0.5 percent in December, and policy-makers may want to shift that expectation lower.

"The Fed will recommit to keeping interest rates low for an extended period,'' said Joseph Brusuelas at Economy.com. "The statement will attempt to talk down long-term interest rates and dampen expectations for a hike.''

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