Retreating U.S. stimulus poses risk to world recovery; Fed could trim bond-buying more sharply in future: Plosser; Fed’s Plosser at odds with policy approach favored by Yellen

Retreating U.S. stimulus poses risk to world recovery

2:04pm EST

By Robin Emmott

BRUSSELS (Reuters) – The world economy should finally overcome its hangover from the global financial crisis this year as growth picks up and house prices rise, but reduced U.S. monetary stimulus will pose a challenge.After months of angst, investors will see how the U.S. Federal Reserve handles its decision to curtail its policy of easy money, starting from this month.

U.S. jobs data on Friday will give markets a sense of the pace at which the Fed plans to pare back its bond-buying program, while minutes on Wednesday from its December 18 meeting will throw light on the central bank’s thinking.

“The United States will be the main focus given the Fed has finally started to taper its asset purchases,” said James Knightley, a senior economist at ING in London, referring to what economists call the “tapering” of U.S. stimulus.

“Nonetheless, the Fed has made it clear that it will not be looking to run down the size of its balance sheet anytime soon, while rate hikes remain some way off,” he said.

The Fed’s stimulus revived the U.S. economy after the biggest crisis since the Great Depression and the U.S. economy is leading the global recovery. The United States could grow by up to 3 percent this year, helping the global economy to expand by almost 4 percent, according to the International Monetary Fund.

The delicate job of bringing the $85 billion-a-month program gradually to an end will almost certainly fall to Janet Yellen, whose candidacy as the next Fed chair will be voted on by the U.S. Senate on Monday.

Yellen, who would become the first woman to chair the U.S. central bank, would take the reins on February 1, the day after Ben Bernanke ends his two-term stint.

CURRENCY CONCERNS

For emerging markets – major beneficiaries of cheap money unleashed by Fed stimulus – a scaling back of the program will prompt investors to reduce their holdings of stocks and bonds. Short-term economic growth could suffer due to a failure to reform during the years of easy money.

Turkey is one country that relies on foreign capital to plug holes in its balance of payments and the country will be in focus again in the week ahead, not least because Ankara faces its greatest period of political instability in a decade.

Markets have calmed since the last week of 2013, when Prime Minister Tayyip Erdogan dismissed police officers involved in a corruption investigation that has dragged in relatives of ministers and others with close links to the government.

But a falling lira is saddling companies with higher payments on foreign loans and pushing up inflation.

Indonesia, also vulnerable in the face of reduced U.S. stimulus due to its sizeable current account deficit, has been at the centre of the sell-off in emerging currencies and will hold a central bank policy meeting with the Fed firmly in mind.

Emerging markets are becoming more of a concern for the global economy as the rich world recovers from the 2008/2009 financial crisis, while China’s slowing economy, which generates more than a third of global growth, has added to the unease.

The world’s second-largest economy releases business surveys, trade, inflation and lending figures in the week ahead.

NO CELEBRATION

Europe offers good news for a change and U.S. Treasury Secretary Jack Lew should hear some of that in a visit to Berlin, Paris and Lisbon for talks with senior officials.

The single currency area is forecast to return to growth in 2014 after two years of contraction and Greece, at the centre of the bloc’s crippling banking and debt crisis, expects its first economic expansion in six years.

Still, European Central Bank President Mario Draghi will be in no mood for celebrating when the bank’s Governing Council meets on Thursday. He faces the difficult task of supporting growth with limited tools in a region still facing record unemployment and high public and private debt levels.

The ECB is banned from buying bonds directly from governments and cannot emulate the Fed, although it can find ways to purchase bonds from banks on the secondary market.

Draghi said last week he saw “no need for immediate action” after cutting interest rates to a record low of 0.25 percent in November, and sees signs of a gradual economic recovery.

“Draghi will merely emphasize once again that the ECB is ready to act,” said Michael Schubert, an economist at Commerzbank in Frankfurt.

Before the ECB meets, euro zone inflation data on Tuesday will show how consumer prices are holding up despite deflationary risks in some of the weaker economies.

Surveys of the euro zone’s service sector are likely to show the currency bloc ended the year on a reasonably robust note, even if France’s tepid performance is a concern.

Outside the euro zone, Britain is in a different position, with growth picking up, unemployment falling and house prices rising, leading to talk of the need for a rate rise sooner rather than later to avoid a real estate bubble.

The Bank of England also holds its meeting on Thursday but no one expects a change in monetary policy this month. For the time being, the consensus remains that rates will rise from their record low of 0.5 percent in 2015.

 

Fed could trim bond-buying more sharply in future: Plosser

6:35pm EST

PHILADELPHIA (Reuters) – The Federal Reserve could well consider cutting its bond-buying by more than a $10 billion monthly increment in the future, Philadelphia Fed President Charles Plosser said on Saturday, floating $25 billion as a hypothetical amount.

The U.S. central bank trimmed its quantitative easing program to $75 billion per month, from $85 billion, at a much anticipated policy meeting last month, reducing its extraordinary support for the U.S. economy.

“It’s good that we did it,” Plosser, a hawkish Fed official, told reporters on the sidelines of a conference. But “if the economy continues to grow and strengthen I think that there’s no reason why we shouldn’t want to consider speeding the process up if we can,” he said.

“I have no problem with gradually unwinding it, but my preference would be to move a little quicker and end it sooner rather than later,” Plosser added.

 

Fed’s Plosser at odds with policy approach favored by Yellen

5:05pm EST

PHILADELPHIA (Reuters) – The Great Recession could have done permanent damage to potential U.S. output, a top Federal Reserve official said on Saturday, taking an indirect shot at more cyclical approaches to policy-making that is favored by many economists, including the next Fed chair.

Philadelphia Fed President Charles Plosser said in a speech he is skeptical of so-called “optimal control” approaches to monetary policy in which mathematical models are used to predict when things like unemployment and economic growth will return to more normal levels.

Fed Vice Chair Janet Yellen, who is set to take the reins at the U.S. central bank next month, has often touted this approach, including tolerating higher inflation for a short time in order to speed up the overall economic recovery.

While Yellen is a dovish backer of the Fed’s aggressive stimulus, Plosser – who regains a vote on policy this year under the Fed’s rotating system – is among the minority of hawks who oppose policies such as large-scale bond-buying.

“Measures that arbitrarily, or by assumption, assign the bulk of fluctuation in GDP to purely temporary factors may provide poor policy guidance when shocks are more permanent in nature,” he said in prepared remarks to the Korea-America Economic Association.

To recover from the recession, the U.S. central bank has held interest rates near zero since late 2008 to spur growth and hiring. It has also quadrupled the size of its balance sheet to around $4 trillion through three rounds of bond purchases aimed at holding down longer-term borrowing costs.

While gross domestic product growth rose above 4 percent in the third quarter, it has generally stayed closer to 2 percent since the recession ended in 2009, causing some to think that longer-term potential GDP growth is no longer the 3-percent rate to which Americans are accustomed.

If that is the case, the Fed’s ultra easy policy stance – including promises to keep rates near zero for a while in order to drive down joblessness – may be misdirected.

“The shock that hit the economy appears to have had very persistent, if not permanent, effects,” Plosser said. “From a statistical perspective, the economy appears to have taken a permanent hit to the output level.”

Yellen and current Fed Chairman Ben Bernanke have stressed the economic recovery has a long way to go, and that the Fed is committed to stimulus as long as needed. Yellen, who is expected to win Senate backing for the chairmanship on Monday, first mentioned an optimal control policy path in June, 2012.

Plosser said he is “skeptical” on “optimal control exercises that are derived from specific models” and not on a variety of models.

“A robust, systematic approach to policy, which is transparent and minimizes the degree to which data mismeasurement and model uncertainty affect policy, is the most promising approach to the uncertainties facing policymakers in real time,” he said.