WSJ - Europe, Weak Economy Add to Pressure on Fed 19/06/2012

WSJ - Europe, Weak Economy Add to Pressure on Fed Federal Reserve policy makers, meeting amid growing concerns about the U.S.recovery and the European debt crisis, have an array of options if they decidethe economy needs an added boost.   Fed officials, concluding a two-day policy meeting Wednesday, could extend aprogram known as "Operation Twist," in which the central bank sells short-termTreasury bills and notes and plows the proceeds into longer-term securities.They also could decide to shift the proceeds into mortgage-backed securitiesrather than long-term Treasury bonds.   Among other choices: launching a new round of bond-buying, known to some asquantitative easing, to expand the central bank's portfolio of assets. Or theycould alter the way they describe their plans for interest rates with anassurance that short-term interest rates will stay near zero beyond 2014.   Policy makers also could stand pat but offer assurance that they stand readyto act if the economy gets weaker.   With the exception of standing pat, all these moves would be aimed atbringing down long-term interest rates and reducing credit costs more broadlyto spur spending and investment.   An array of recent lackluster economic news--coupled with jitters aboutEurope's crisis--has transformed the Fed's calculations. A few months ago, whenthe economic outlook was brighter, officials didn't consider taking any ofthese actions: now all are on the table.   Fed officials are likely to lower their forecasts for U.S. growth this year,in light of the weak data on jobs, factory output and retail sales. The figureshave raised fears the U.S. recovery is faltering for a third consecutive yearat the same time that global growth is slowing and Europe's financial woes aremounting.   The Fed is most likely to continue Operation Twist, according to a WallStreet Journal poll of 51 economists, who gave the step an average likelihoodof 44%.   Extending the Twist program is among the more attractive of the Fed'soptions, in part because the program has stirred relatively little controversy.  At the same time, however, its impact is limited and its effects likely wouldbe more muted if the central bank attempts to extend it, some economists said.   Unlike starting another major bond-buying program, extending Operation Twistdoesn't expand the Fed's portfolio of assets and isn't expected to affect theinflation outlook much. That makes the program more palatable to Fed officialsconcerned that more ambitious steps might spur inflation worries. It alsoappeals to those who feel the central bank should be doing more to bring downthe unemployment rate, now 8.2%. But Twist offers less firepower than anotherbig round of bond buying to help support the fragile recovery, according toeconomists.   "If you believe what ails the economy is not solely dependent on interestrates, as we do, then slightly lower interest rates is only going to make aslight difference," said Dan Greenhaus, chief global strategist at BTIG LLC. IfFed policy can help strengthen the recovery, then continuing Twist is only a"half-baked measure," he said.   A second round of Operation Twist is likely to be smaller than the first $400billion program, since the Fed likely would have only about $240 billion ofshort-term Treasurys left to sell, said Michael Feroli, chief U.S. economist atJ.P. Morgan Chase & Co. (JPM). For example, a $150 billion extension ofOperation Twist over several months might lower longer-term interest rates byabout .05 to .10 percentage point, which in turn might increase gross domesticproduct growth over the next two years by about 0.1% per year, he said.   Some think the Fed might be able to amplify the program's influence by buyingsome mortgage-backed securities instead of more long-term bonds, puttingdownward pressure on mortgage interest rates.   "Because the housing market has been one of the core sources of weakness,[the Fed] would be trying to target that segment which has been holding backthe economy," said Craig Alexander, chief economist at TD Bank Financial Group.But, as in other areas, "mortgage rates are already so low, it's hard to seehow a little bit lower interest rates would have a significant impact on themarket," he said.