Investors hoping for Fed action to boost economy

[June 20, 2012]  WASHINGTON (AP) -- The Federal Reserve, meeting at a time of heightened uncertainty, is expected to provide further support for a slumping U.S. economy. But there is no consensus over what form the added support will take.

Some private economists believe the Fed will launch another round of bond buying in an effort to drive long-term interest rates even lower. The aim would be to spur more borrowing, spending and economic growth.

At the very least, many economists believe the Fed will stress its readiness to do more should the economy weaken further.

The Fed was scheduled to conclude its two-day meeting on Wednesday with the release of a statement outlining any changes in policy. That will be followed by an updated economic forecast from the central bank and then finally a news conference by Fed Chairman Ben Bernanke.

Wall Street rallied on hopes that the Fed will announce that more help is on the way. The Dow Jones industrial average climbed 95.51 points on Tuesday to its highest close in a month.

Bernanke and other Fed officials have acknowledged the U.S. economy is sputtering and the threats posed to it by Europe's debt crisis.

The Fed has kept its key policy lever, the federal funds rate, at a record low near zero since December 2008. And it has said it plans to keep it there until at least late 2014.

Given that it can't drive short-term rates any lower, the Fed has tried to further reduce long-term rates by buying more than $2 trillion in Treasury bonds and mortgage-backed securities. The idea is for those lower rates to help boost spending, hiring and economic growth.

Bernanke has sent no clear signal of the Fed's next move. He has said Fed officials need to see whether the economy can grow fast enough to accelerate hiring. U.S. employers added just 69,000 jobs in May. Since averaging a healthy 252,000 a month from December through February, job growth has slowed to a lackluster average of 96,000 over the past three months.

Here's a look at the Fed's options:

EXTEND OPERATION TWIST

Under Operation Twist, the Fed has been gradually selling $400 billion in short-term Treasury securities since September and using the proceeds to buy longer-term Treasurys.

In doing so, the Fed seeks to "twist" long-term rates lower relative to short-term rates. Operation Twist has the advantage of potentially lowering long-term rates without expanding the Fed's record-high portfolio. When the Fed expands its portfolio of investments, critics argue that it raises the risk of high inflation later.

Operation Twist is set to expire at the end of the month. Many analysts say the Fed will announce it will continue to swap short-term securities it owns for longer-term securities for a few more months. But the benefit would likely be slight. The Fed has a dwindling supply of short-term securities it can swap. Some think any new Operation Twist would be only about half the size of the expiring program.

QEIII

When the Fed expands its portfolio by buying more bonds, it's called quantitative easing, or QE. It's already engaged in two rounds of QE totaling more than $2 trillion. A possible third round has been dubbed QEIII.

This would be the most dramatic move the Fed could make to try to further drive down long-term rates. It would also trigger the most criticism because it would expand the Fed's holdings by billions more dollars.

Opponents warn that further bond purchases would do little to help and would risk higher inflation in the future.

Republican presidential candidate Mitt Romney said on CBS's "Face the Nation" on Sunday that another round of Fed bond purchases would "put in question the future value of the dollar and it will obviously encourage inflation down the road."

Supporters of further bond purchases counter that last week's news that consumer prices fell in May by the most since late 2008 showed that inflation is hardly a threat.

More bond purchases, if they were to lead to lower rates, could also lift the stock market if they led many investors to shift money out of low-yielding bonds into stocks. The Securities Industry and Financial Markets Association issued a survey Tuesday showing that two-thirds of the Wall Street economists it surveyed expect the Fed to announce more bond buying.

STRONGER LANGUAGE

Under this option, the Fed would change the wording of the statement it issues after each meeting. It could do so in two ways. It could be more definitive in pledging to help should the economy weaken further and perhaps spell out what those steps could be.

Or it could push back its time frame for when it expects to begin raising short-term rates beyond its current target of late-2014, until some time in 2015.

DO NOTHING

This would represent a continuation of the Fed's decisions at its policy meetings in March and April. After each of those meetings, it kept its policy-making on hold. But a no-change meeting would risk disappointing investors and triggering a sell-off on Wall Street. That, in turn, could further dampen consumer and business confidence, an outcome the Fed would not like to see.

[Associated Press; By MARTIN CRUTSINGER]

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