Fed seen maintaining QE pace to avert a fourth summer slump

Crisis Flared

Last year, Europe’s debt crisis flared again. The S&P 500 fell 4.2% from the start of April until June 29. That month, the FOMC extended Operation Twist. In September, it launched QE3. The economy grew 1.7% for the year, below policy makers’ 2.2% to 2.7% forecast.

This year, fiscal policy is again at the heart of the Fed’s concerns.

March marked the start of $1.2 trillion in across-the-board Federal spending cuts to be spread over 10 years. The cuts, which will trim 5% of the spending from domestic agencies and 8% from the Defense Department this fiscal year, follow income-tax increases for the most affluent Americans and a two-percentage-point increase in the payroll tax.

The “greatest danger” to growth is tighter fiscal policy, Dudley said in a March 27 speech.

“We could very well in the summertime start seeing the effects of the fiscal tax increase and spending cut slow us down again,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington and a former Fed economist.

Factory Index

There were signs of economic weakness even before last week’s payrolls report. The Tempe, Arizona-based Institute for Supply Management’s factory index for March fell more than forecast, and its services gauge showed the slowest pace of expansion in seven months.

In contrast to its previous quantitative easing programs, the Fed’s current round of asset purchases is open-ended, with no final date or amount specified in advance. That means policy makers can maintain stimulus until the economy gains a more stable footing.

“It helps that we’ve removed one source of uncertainty which is, how will the Fed react?” said Julia Coronado, chief economist for North America at BNP Paribas in New York. “Instead of asking how bad things need to get for the Fed to do more, it’s how good do they need to be before they stop helping.”

Bloomberg News

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