Fed Worried About Housing Recovery at December Meeting

Some U.S. Federal Reserve officials worried last month that waning government support could snuff out a fragile housing market recovery and a few believed it might be desirable to step up asset purchases.

CNBC.com

"Some participants...noted the risk that improvements in the housing sector might be undercut next year as the Federal Reserve's purchases of (mortgage-backed securities) wind down, the homebuyer tax credits expire, and foreclosures and distress sales continue," minutes of the Fed's Dec. 15-16 policy-setting meeting said.

Labor market weakness remained an important concern for Fed officials, the minutes released on Wednesday showed, with officials saying they expect unemployment to remain high for "quite some time." Views about policy differed.

Some officials said persistently high unemployment might make it desirable at some point to expand or extend large-scale purchases of assets.

However, one policy-maker said improvements in financial markets and in the economy may warrant scaling back the Fed's purchases and reducing holdings over time.

Fed officials said that in general, the outlook for housing was for gains in activity to continue, although some participants viewed the improvements as "quite tentative." Mortgage markets could come under pressure when the MBS purchases wind down, some officials worried.

The Fed has committed to buying $1.25 trillion of mortgage-backed securities by the end of March.

The Fed began buying MBS, mortgage agency debt and longer-term Treasury securities after it had cut rates to near zero in December 2008 but wanted to continue to provide a boost to the economy.

A $300 billion program to purchase longer-date Treasuries ended in October.

At the Dec. 15-16 meeting, the Fed decided to continue keeping interest rates low for an "extended period" to keep the economic recovery going and drive down double-digit unemployment.

But in a more upbeat assessment, the Fed said the economy had "continued to pick up" and that "deterioration in the labor market is abating," a nod to the recent slowdown in the pace of layoffs.

Meanwhile, a Fed economist said Wednesday that the central bank's extraordinary support for the financial system suggests it will have less margin for error to stave off inflation as recovery gathers steam.

The Fed has more than doubled the size of its balance sheet to around $2 trillion, worrying some economists that inflation will result once the economy recovers.

Some of the Fed's special lending facilities are winding down on their own as financial conditions improve, St Louis Fed economist Kevin Kliesen wrote in the regional central bank's quarterly review of business and economic conditions.

"Still this process will not be sufficient to prevent a potentially destabilizing surge in money growth, which means that Fed policymakers will have to adopt other, more aggressive strategies," Kliesen wrote.

Fed officials have said options include paying interest on excess reserves and selling some assets on its balance sheet.

"Regardless of the method used, an improving economy means that the Fed must be prepared to raise its interest rate target to prevent an unwanted expansion in money growth by the banking sector," Kliesen wrote.

Fed Chairman Ben Bernanke and other policy-makers are "quite confident" that they have the tools and determination needed to prevent an unwelcome acceleration in inflation and inflation expectations, Kliesen wrote.

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"Unlike previous episodes, though, the magnitude of the policy responses to the financial crisis and the Great Recession suggests that the FOMC's margin of error seems much smaller than at any time in the Fed's history," he wrote.

Kliesen noted there is a "considerable amount" of disagreement among economists about the outlook for inflation over the next couple of years.

Some place more emphasis on high unemployment putting a damper on inflation while others believe the risks of higher inflation have increased due to large budget deficits and the Fed's asset purchase programs.

Kliesen suggested disagreement on the inflation outlook could provide some insight into what lies ahead, noting that past five-year forecasts of the average Consumer Price Index inflation rate from Blue Chip Economic Indicators show that when inflation was relatively high and variable, such as the late 1980s and early 1990s, there was sizable disagreement among forecasters about the medium-term inflation outlook.

"By contrast, during periods when inflation tends to be relatively low and stable, such as the mid-1990s to mid-2000s, forecasters tend to disagree less about the... outlook."

by reuters and cnbc.com