Fed cites unemployment in sticking with bond plan (AP)

WASHINGTON – The Federal Reserve said Tuesday it will maintain the pace of its $600 billion Treasury bond-buying program because the economy is still too weak to bring down high unemployment.

The Fed’s bond purchases are intended to lower long-term interest rates, lift stock prices and encourage spending. Its decision not to increase its purchases rattled bond investors, who fear a tax-cut plan in Congress could fuel enough growth to drive up interest rates.

Chris Rupkey, an economist at Bank of Tokyo-Mitsubishi UFJ, said investors worry the Fed’s bond-buying plan won’t achieve its goal of reducing long-term rates. Those rates have been rising as investors have raised expectations for growth and inflation, especially as a tax-cut plan takes shape in Congress.

“Maybe bond buyers wanted to hear the Fed say it’s not working, so we will buy more,” Rupkey said of the bond purchases.

Fed policymakers said they’ll continue to monitor the program. They left open the option of buying more bonds if the economy weakens, or fewer if it strengthens more than expected.

After the Fed issued its statement, Treasury prices sank, pushing their yields higher. The yield on the 10-year Treasury note jumped to 3.46 percent, its highest level since May and well above the 3.28 percent it traded at late Monday. The yield on the 10-year note helps set rates on many kinds of loans including mortgages. Higher rates could slow, and potentially derail, the economy’s progress.

They could also weigh on the stock market. Stock prices lost some of their gains after the Fed issued its statement. The Dow Jones industrial average closed up about 48 points. Broader market averages posted slighter gains.

Critics contend that the Fed’s bond-purchase program would do little to help the economy and could hurt it by fueling inflation and speculative buying in assets like stocks.

The Fed, in its statement, said it saw no threat of inflation. The Fed once again left its key short-term interest rate near zero, where it has been since December 2008. It also repeated its pledge to hold rates at those ultra-low levels for an “extended period.”

The broad tax-cut plan emerging in Congress is easing pressure on the Fed to stimulate growth through its bond purchases. But if interest rates keep rising, the Fed may have to step up its bond purchases to drive those rates back down.

“The Fed’s job is becoming more complicated,” Ken Mayland, president of ClearView Economics, said of rising interest rates.

In deciding to stay the course, the Fed said the “economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment.”

Other than spotlighting the high unemployment rate, the Fed’s statement was essentially the same as the one issued after policymakers adopted the bond-buying program at their Nov. 3 meeting.

Unemployment rose to 9.8 percent in November, a seven-month high. It’s exceeded 9 percent for a record stretch of 19 months. And some economists predict it could climb to 10 percent by early next year.

Concerns about persistently high unemployment were the main factor behind the Fed’s decision to launch a second round of bond purchases on Nov. 3. Progress in its goal of reducing unemployment has been “disappointingly slow,” the Fed said Tuesday, echoing language it used last month.

Looking at other parts of the economy, the Fed said consumer spending is rising at a moderate pace but is constrained by high unemployment, scant pay gains, weak home values and tight credit.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, dissented Tuesday for an eighth straight meeting. All year, Hoenig voted against the Fed’s actions to shore up the economy — from holding rates at record lows near zero to the $600 billion bond-purchase program.

Hoenig has said he doesn’t think the economy needs the extra help. And he warns the Fed’s actions could trigger inflation and a wave of speculation in financial markets.

In the policy statement released after its meeting, the Fed made no mention of the tax-cut plan, which is designed to bolster the economy.

Key elements of the tax-cut plan include: Extending 2001 and 2003 income tax cuts for two years; renewing long-term unemployment benefits for 13 more months; and reducing workers’ Social Security taxes in 2011. Economists say it will boost spending by individuals and businesses. That would strengthen growth and lead companies to hire more.

“That surely puts less of the burden to boost growth on the Fed,” Paul Dales, economist at Capital Economics, said of the tax cut package.

Even so, Dales and other economists say they believe the Fed will carry out its $600 billion purchases of government bonds by the end of June, as scheduled. But if the economy gains momentum next year, the Fed might scale back its program.

The Fed’s next meeting is Jan. 25-26.

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