Despite Slowing Economy, Fed Is in No Hurry to Act

The economy is growing more slowly than last quarter, but probably not enough to push the Federal Reserve into action next week.

Woman shopping for clothing
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Woman shopping for clothing

U.S. gross domestic product, the value of all goods and services produced, grew at a pace of 1.5 percent in the second quarter, down from a revised 2 percent in the first quarter.

Traders had been watching to see if the number, reported Friday, would signal a growth scenario that would encourage the Fed(explain this) to be more aggressive at its two-day meeting next week.

“It’s not an emergency. I think they’ll be inclined to wait for September,” said Peter Fisher, head of BlackRock’s Fixed Income Portfolio Management Group.

Fisher said he expects the economy to have been growing at about 2 percent and, all told, that’s what the data and revisions show.

Fourth-quarter growth was revised from 3 percent to 4.1 percent, and the revisions show that 2011 was slightly better than thought. The first quarter was raised by 0.1 percent.

“There’s no news here,” Fisher said.

Barclays’ chief U.S. economist Dean Maki said the 1.5 percent growth was just what he expected, and he sees a slight pickup to 2 percent in the third quarter. Consensus was for second-quarter growth of 1.4 percent.

“We think they’ll continue with what they’re doing, the Operation Twist, but not proceed with any further easing measures,” he said. “We believe the Fed is in data watching mode right now. Waiting to see whether GDP and job growth pick up in the third quarter or not. If they do, we think the Fed will simply proceed with the current Operation Twist and not launch any further easing measures.”

“However, if there’s not evidence of a pickup, we think the odds favor a further Fed action,” Maki said.

Many Fed watchers believe September is the earliest that the Fed would act, if it decides to embark on another round of quantitative easing (explain this), or QE.

A QE program this time would be expected to target mortgage securities, instead of Treasurys, as the Fed has purchased in the past two rounds of QE.

Operation Twist is different from QE, in that the Fed purchases Treasurys at the longer end of the curve (explain this), while selling the same amount of shorter duration Treasurys, without changing the size of its balance sheet in the process.

Traders say the idea of a QE3 has been providing some support to stocks, which along with commodities, have risen on past QE. But this time, corporate profits are showing strain and with ultra-low Treasury yields, some analysts question how effective another round of easing would be. Fed officials, themselves, have said the benefits of further easing would have to outweigh the costs.

Some Fed watchers expect the Fed next week to lengthen the time frame on its forecast for extreme low rates to mid-2015, from the end of 2014.

“I think it would be odd for the Fed to do that, to indicate they think things will be weaker for longer, but take no action,” said Maki.

The next key data for the Fed to ponder is the July employment report, expected next Friday. Maki expects to see growth of 100,000 jobs, up from the 80,000 added in June.

“We do think if we see that type of improvement in the next couple of reports that would be enough to keep the Fed on hold,” he said. “What would not be alright with the Fed is further deterioration over the next couple of months.”

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