Investors await Fed’s decision on bond purchases

Investors are waiting to see whether one of Ben Bernanke's final acts as chairman of the Federal Reserve will be to announce a pullback in the Fed's bond purchases. The purchases have been intended to keep long-term loan rates low to spur economic growth.

It's a close call.

But most economists think that when the Fed's latest policy meeting ends Wednesday, it will announce that it's maintaining its pace of $85 billion a month in bond purchases despite a drop in unemployment to 7 percent and other improving economic data.

One factor in the Fed's hesitance to reduce its stimulus is that inflation remains historically low. The Fed's optimal rate is 2 percent. For the 12 months ending in October, consumer inflation as measured by the Fed's preferred index is just 0.7 percent, well below its target. The Fed is as concerned about under-shooting the inflation target as over-shooting it. Both are seen as threats to the economy.

On Wednesday, Bernanke will also give his final quarterly news conference. His second four-year term as chairman ends Jan. 31, when Vice Chair Janet Yellen will likely succeed him. The Senate is expected to approve Yellen's nomination this week.

Most analysts think the Fed will start trimming its bond purchases at one of its next two meetings, either in January or March.

The decision carries high stakes for individuals, businesses and global financial markets. A pullback in the bond buying would likely send long-term rates up and stock and bond prices down.

That the Fed is even considering slowing its stimulus is testament to the economy's improvement. Hiring has been robust for four straight months. Unemployment is at a five-year low of 7 percent. Factory output is up. Consumers are spending more at retailers. Auto sales haven't been better since the recession ended 4½ years ago.

What's more, the stock market is near all-time highs. Inflation remains below the Fed's target rate. And the House has passed a budget plan that seems likely to avert another government shutdown next year. The Senate is expected to follow suit.

"It really feels like the economy has finally hit escape velocity," said Mark Zandi, chief economist at Moody's Analytics, citing a term Bernanke has used for an economy strong enough to propel growth and shrink unemployment without the Fed's extraordinary help.

Still, only one-fourth of more than three dozen economists surveyed last week by The Associated Press expect the Fed to scale back its bond purchases this week.

The economists surveyed by the AP think Yellen will be more "dovish" than Bernanke — that is, more likely to stress the need to reduce still-high unemployment than to worry about inflation that might arise from the Fed's policies.

Bernanke's mention in June that the Fed might start to reduce its bond purchases before year's end sent stocks and bonds into a temporary tailspin. They have since recovered. Stocks are trading near new highs. And the rate on the benchmark 10-year Treasury has stabilized, though it's still a full percentage point above its level in early May.

The calmness among investors suggests that they've absorbed a point Bernanke has stressed repeatedly: That even after the Fed scales back its bond purchases, it will still provide significant support for the economy. Fed officials have invoked the imagery of a driver easing up on a gas pedal without pressing the brakes.

In addition, the Fed plans to leave its key policy lever for short-term rates at a record low near zero, where it's been since December 2008. It's said it plans to leave its short-term rate ultra-low at least as long as unemployment remains above 6.5 percent and the outlook for inflation doesn't top 2.5 percent.

An unemployment rate of 6.5 percent wouldn't automatically trigger a rate increase, Bernanke has said. To stress that short-term rates will remain ultra-low, some Fed officials favor announcing an unemployment threshold of 6 percent before any rate increase would be considered.

Some economists think the Fed may decide to leave its policy unchanged in December just because Bernanke and other officials have sent no clear signal of their intentions.

"Reducing bond purchases is going to happen at some point, but I don't think they have done enough explaining yet to prepare the markets for the move," said Diane Swonk, chief economist at Mesirow Financial.

Once the Fed does slow its bond purchases, many economists think it will start by reducing its monthly pace by just $10 billion to $75 billion. But much will return on the collective decision-making of a policy committee with an evolving membership.

Because of the transition from Bernanke to Yellen and the need to fill other spots on the Fed's policy panel, economists In part because of such changes, some think the Fed might decide not to trim its bond purchases until March — the first meeting with Yellen in charge.

"I think they will wait until March when they have a new team in place," said Sung Won Sohn, an economics professor at the Martin Smith School of Business at California State University.