Fed Officials More Confident Recession is Ending
With the economy on the mend, Federal Reserve policymakers last month felt comfortable slowing the pace of one of its economic revival programs and not changing any others, according to documents released Wednesday.
Minutes of the central bank's closed door deliberations, held Aug. 11-12, also showed Fed Chairman Ben Bernanke and his colleagues striking a much more hopeful note about the economy's prospects compared with an assessment made in late June. Many Fed officials saw "smaller downside risks," the documents stated.
Fed officials expected the pace of the recovery to "pick up" in 2010, but there was a range of views — and considerable uncertainty — about the likely strength of the upturn because of concerns about how consumers will behave.
After being pounded by the recession, consumer spending finally appeared to be leveling out, the housing market was firming and manufacturing was stabilizing, the Fed said. Plus, the outlook for other countries' economies improved, auguring well for the sale of U.S. exports.
All that strengthened the confidence of Fed officials that "the downturn in economic activity was ending." They also repeated a prediction that the economy would start growing again in the second half of this year. That expected growth will be helped by President Barack Obama's $787 billion package of tax cuts and increased government spending, they said.
Against that backdrop, the Fed at its August meeting, announced that it would gradually slow the pace of its program to buy the remainder of $300 billion worth of Treasury securities and shut it down at the end of October, a month later than previously scheduled. The program is designed to force interest rates down for mortgages and other consumer debt, and spur Americans to spend more money.
The Fed also did not change another program that aims to push down mortgage rates. In that venture, the Fed is on track to buy $1.25 trillion worth of securities issued by mortgage finance companies Fannie Mae and Freddie Mac by the end of the year.
"With the downside risks to the economic outlook now considerably reduced, but the economic recovery likely to be damped" Fed policymakers agreed that it didn't need to either expand or cut back those programs.
Summing up the Fed minutes, "the overriding theme is that the economy was just beginning to turn around," said Stephen Stanley, chief economist at RBS.
Fed officials suggested consumers will be a wild card in the unfolding recovery.
A "poor" jobs market, evaporated wealth from decimated home and stock values, hard-to-get credit and wages that aren't supposed to advance sharply anytime soon mean consumers are still facing "considerable headwinds," the minutes said. How consumers behave is crucial to the recovery because their spending accounts for roughly 70 percent of all economic activity.
"With these forces restraining spending, and with labor income likely to remain soft, (Fed) participants generally expected no more than moderate growth in consumer spending going forward," the Fed minutes stated.
Unemployment — now at 9.4 percent and expected to top 10 percent this year — is the biggest burden facing American consumers. Another source of uncertainty: the extent to which consumers will sock more money into savings, the Fed said.
To entice consumers to spend more, the Fed last month also left a key interest rate at a record low of near zero. It pledged to hold that bank lending rate at between zero and 0.25 percent for an "extended period." Economists predict that means through the rest of this year and may be longer.
"We suspect that it won't raise interest rates possibly until 2011," said Paul Dales, economist at Capital Economics Ltd.
As a result, commercial banks' prime lending rate, used as a peg for rates on home equity loans, certain credit cards and other consumer loans, will stay at about 3.25 percent, the lowest in decades.
Given weakness in the job market and that factories — while improving — are far from full throttle, inflation should stay contained, the Fed said. Fed officials did, however, acknowledge that some on Wall Street have expressed worry that the central bank's aggressive actions and the federal government's bloated budget deficit will spur inflation later on.
To address those concerns, the Fed said it is important to keep sending the message that it has the will and the tools necessary to reel in the trillions of dollars it has pumped into the financial system to revive the economy.