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Fed to Weigh Further Easing Amid Doubts About Recovery

Federal Reserve officials are seriously considering giving the US economy—and especially the housing market—an added jolt with more quantitative easing.

United States Federal Reserve
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United States Federal Reserve

Fed officials are likely to discuss such a move at their Jan. 24-25 meeting, when the central bankwill issue its first quarterly forecast on interest rates under the new communication policy.

Two of the new voting members this year on the Federal Open Market Committee , which sets interest-rate policy, have recently suggested they would support more assets purchases.

San Francisco Fed President John Williams said that sustained high levels of unemployment, as forecast by many Fed members, "does make an argument that we should have more stimulus."

Another new voter, Cleveland Fed President Sandra Pianalto, said in a recent speech that economic models indicate the Fed "should be even more accommodative than it is today."

They join other members, including New York Fed President Bill Dudley and several Fed governors, who have openly suggested they would support more QE .

As part of an normal rotation of presidents, the makeup of the FOMC will become more dovish this year.

Three hawkish members are losing their FOMC vote—Richard Fisher of Dallas, Narayana Kocherlakota of Minneapolis and Charles Plosser of Philadelphia—along with only one dovish member, Charles Evans of Chicago.

They will be replaced by two more dovish members—Williams and Pianalto—and Dennis Lockhart of Atlanta, who is moderate but is seen as unlikely to dissent.

But a more dovish makeup is just one reason that more QE could become a reality this year.

Fed officials harbor doubts about the strength of the economic recovery and note there is considerable slack. And they expect inflationto remain moderate this year.

It is also significant that financial markets expects the Fed to act.

The newly released primary dealer survey from the Fed shows that top Wall Street fixed income dealers put a 60% probability on the Fed boosting the size of its balance sheet within a year.

Much will depend on the economic data during the first quarter. One concern inside the Fed is that much of the recent economic strength results from one-time factors, such as rebuilding inventories.

Taking out inventories, underlying GDP still looks weak to some Fed officials. Meanwhile, income growth has also been lagging, suggesting any spending gains from the holiday season likely came from savings. Fed officials generally see this as unsustainable.

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The most likely course for the Fed is to gauge what kind of effect its latest innovation—publishing the expected interest rate path from its members—will have on bond yields.

There is hope that if the path shows that Fed officials put the date of the first rate increase further down the road than the market expects, that could edge down long-term rates.

But the minutes of the December meeting also showed that for “a number” of officials, this new communications strategy is not a replacement for more easing, but rather, a precondition.

Already some Wall Street banks are building QE3 into their forecasts. Morgan Stanley fixed income economist David Greenlaw said he expects more easing to be announced this spring.

Greenlaw said it’s “based on an expectation that the bar is pretty low for additional accommodation and we do expect some modest slowing in economic activity in early 2012.”

He sees Fed purchases beginning in June, around the time that Operation Twist is ending.

The new program will likely concentrate on mortgage-backed securities in an explicit attempt by the Fed to provide more help to the housing market.

Economist Dean Maki from Barclays doesn't believe more easing is necessary but he still puts a 40% probably on it happening. Maki suggests an April announcement would be most likely since that would be the next news conference for Fed chairman Ben Bernanke following the one this month.

To be sure, such a policy will almost certainly not be unanimous. Richmond Fed President Jeff Lacker, the lone committed hawk on the FOMC, suggested in a CNBC interview this week that he could dissent on a vote on additional QE. (See video interview above and click here for story)

“The Fed doesn't control growth. We can interfere with it. We can impede it,’’ Lacker said. “But in general the growth rate the economy can crank out is determined by technology, people's preferences, resource endowments, other policies and the like. Our job is to keep inflation low and stable.”

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