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Federal Reserve To Trim Bond Purchase Later This Year

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The Federal Reserve is expected to signal at its June policy meeting that they are on track to start winding down the $85 billion a month bond purchase program, says Jon Hilsnerath of the Wall Street Journal. Today, the Labor Department reported modest jobs data, indicating that the Fed won’t act right away.

Federal Reserve To Trim Bond Purchase Later This Year

The Federal Reserve may wait to see more data before deciding on whether to roll back the stimulus program. Last month, Ben Bernanke indicated that the Central Bank may start winding down the program in the next few meetings. Many other regional Fed officials also echoed the same view. The next meeting is scheduled for June 18-19, with another one in July and another in September.

Fed Wants to See Effects of Spending Cuts and Tax Hikes

The uncertainty over the stimulus pullback has been a big concern for the stock and bond markets for several weeks. The Fed also puzzled the markets by sending mixed messages. Its April policy meeting statement suggested plans to increase the stimulus program. But the minutes of the meeting showed that many officials wanted to trim it as soon as June.

The Federal Reserve has clearly stated that it will end the program only after there is a substantial improvement in employment. Economists think the jobs market and overall economy have made sufficient progress to consider a partial pullback of the program. But there are still some reservations. Many Fed officials expect that the recent tax hike and spending cuts will hamper economic growth in the second and third quarters. So, they want to see how the economy weathers spending cuts and tax increases before reducing the asset purchase program.

The Federal Reserve thinks that the private sector has enough strength to drive growth later this year. The housing market is recovering. Consumer spending is holding up well. Friday’s jobs data is unlikely to change the Federal Reserve’s view.  The unemployment rate rose from 7.5% in April to 7.6% in May, although it has fallen 0.5% since August when the Fed launched its quantitative easing. Including 175,000 new jobs in May, the U.S. economy has added 190,000 new jobs a month since August.

Three Factors Challenging the Federal Reserve

One factor challenging the Federal Reserve is that it has to manage the signals it sends to the market. Officials have stated publicly that they will proceed cautiously, but markets have reacted with high volatility. The Fed is now worried that markets could overreact even if there is a small cut in bond purchasing.

Inflation is another concern. The Federal Reserve has an objective to achieve a 2 percent inflation rate this year, but the actual inflation is expected to be  1.3  to 1.7 percent. Fed officials now say inflation is likely to move towards to a 2 percent objective later this year. If it doesn’t, the bond purchase may last longer than planned.

The third concern is serious but funny. There is a high risk of errors in the Federal Reserve forecasts. For the past several years, the actual economic growth has been lower than what officials have expected.

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