Fed officials fear risks of more easing

@CNNMoney July 11, 2012: 3:48 PM ET
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NEW YORK (CNNMoney) -- Minutes released from the Federal Reserve's latest meeting Wednesday show the central bank is wary that its efforts to boost the economy also come with risks to the bond market.

The Fed has been buying unprecedented amounts of Treasuries since 2008, trying to push interest rates as low as possible to stimulate the economy.

At its meeting in June, Fed officials voted in favor of continuing those efforts. Their latest move included an extension of a policy known as Operation Twist, which swaps short-term bonds for ones with longer durations. That policy is meant to push long-term interest rates lower.

But Fed officials were not without concerns.

"Some members noted the risk that continued purchases of longer-term Treasury securities could, at some point, lead to deterioration in the functioning of the Treasury securities market that could undermine the intended effects of the policy," the minutes said.

Bond yields typically serve as an important measure for the Fed, acting as a signal on everything from future inflation expectations to the overall health of the U.S. economy. But as the Fed becomes a larger player in the market, those signals could get cloudy.

"As the Fed gets a bigger and bigger share of Treasuries, you lose that signal from the private sector," said Dean Croushore, chair of economics at the University of Richmond and former Fed economist.

The minutes go on to say that, at the moment, Fed officials "generally agreed that such risks seemed low." At $11 trillion, the Treasury market is massive. The Fed currently holds about $1.7 trillion in Treasuries.

That said, the officials asked staff to look into the issue further.

"A few members observed that it would be helpful to have a better understanding of how large the Federal Reserve's asset purchases would have to be to cause a meaningful deterioration in securities market functioning, and of the potential costs of such deterioration for the economy as a whole," the minutes said.

Some members also said that they would like the Fed to consider "new tools to promote more accommodative financial conditions."

Could the Fed be hinting that any additional easing might veer away from Treasuries?

"Our own view is if the Fed moves toward additional easing, it's likely to take the form of purchases of other government-backed paper like mortgage-backed securities," said David Resler, chief economic adviser at Nomura Securities.

Calls for more easing are growing louder from Wall Street, and some Fed officials have noted that they would be open to doing more, especially as the unemployment rate has remained stubbornly high.

Speaking earlier this week, San Francisco Fed President John Williams said he supports "sufficient monetary accommodation to keep our economy moving toward our employment and price stability mandates."

He remarked that buying mortgage-backed securities would be an effective tool. Charles Evans, president of the Chicago Fed, has said he too supports buying mortgage-backed securities.

Critics, including former FDIC Chair Sheila Bair, have accused the central bank of inflating a bond bubble. As the Fed has become one of the largest buyers in the bond market, Treasury prices have risen to levels that some say are unwarranted by the United States' fiscal situation. To top of page

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