Recovery 'picking up,' but Fed stays cautious

Paul Vieira, Financial Post

OTTAWA -- The U.S. Federal Reserve acknowledged Wednesday the economic recovery has "picked up" and financial markets have "improved," but suggested it is in no hurry to pare back stimulus measures.

Among the new details released in the Fed's fixed-date rate announcement was a decision to extend a program, by three months, under which it pledged to acquire up to US$1.45-trillion of mortgage-backed securities and debt.

The mortgage debt program was set to expire on Dec. 31, and to date the Fed had acquired US$810-billion, or just over half, of the amount targeted.

An extension would slow the pace of weekly purchases the Fed executes. Nevertheless, the move suggests the Fed, led by chairman Ben Bernanke, remains committed to the scheme to fuel activity in the battered housing sector, and get the U.S. economy back on its feet.

"It sends a powerful signal that the Fed is not about to withdraw from their support for the economy," said Carlos Leitao, chief economist and strategist at Montreal's Laurentian Bank Securities. "They are not even considering any sort of exit strategies."

The U.S. mortgage debt targeted is a combination of mortgage-backed securities and bonds issued by Fannie Mae and Freddie Mac. The purchases are intended to lower the cost of taking out a mortgage, and, hence, encourage people to enter the housing market. In its statement, the Fed said activity in the housing sector has increased in recent weeks.

"It shows the Fed is very committed to continuing significant purchases to keep mortgage rates as low as possible," Michael Gregory, senior economist at BMO Capital Markets, said.

In stark contrast stands the Bank of Canada, which announced plans to shut down or scale back programs intended to provide capital markets with emergency liquidity to deal with the financial crisis.

"Financial markets have improved to such an extent that the demand for our [liquidity] has been waning," David Longworth, deputy governor at the Bank of Canada, said in a speech Wednesday to a business group in Prince Edward Island.

The removal of trillions in stimuli is among the key tasks that central banks
worldwide face. Central banks must determine the precise moment when the economy can move forward without further stimuli. The risk is moving too early and pushing the economy back into a tailspin, or move too late and allow deadly inflation to be unleashed.

The Fed's efforts to avert a depression has resulted in a ballooning of its balance sheet – from a pre-crisis level of US$929-billion to over the US$2-trillion mark.

In the Fed's statement, released after a two-day meeting of its open market committee, suggested household spending seemed to be "stabilizing." But consumer spending, which is the major driver of the U.S. economy, remains "constrained," the Fed added, due to "ongoing job losses, sluggish income growth, lower housing wealth, and tight credit."

Given these economic conditions, the Fed said it needed to keep the Fed funds rate at virtually zero "for an extended period."

Other analysts, meanwhile, picked up on a slight change in Wednesday's Fed statement that indicates the central bank has started thinking about the post-crisis economy. Wednesday's statement indicated the Fed was prepared to use "a wide range of tools" to fuel growth, while the August statement suggested "all available tools" would be employed.

"To us, this is a signal by the Fed that it will continue to gradually reduce the dose of the medicine that it will use on the economy," Millan Mulraine, economics strategist at TD Securities, said of the change in language.

"However, in recognition that the recovery, at least at its initial stages, will be
tenuous at best, they continue to indicate their willingness to maintain their support for the economy, as they nurse it back to health -- though they will reduce the dosage."