Fed begins policy meeting, tiptoes toward easing

The Federal Reserve opened a two-day meeting on Tuesday that is expected to end with a decision to stock up on longer-term Treasury notes in a bid to boost a fading economic recovery.

With the United States at risk of a new recession and the political climate in Washington making prospects for fiscal stimulus uncertain, the Fed has made it clear it is intent on taking steps to lift growth, even if only modest ones.

Although officials differ on how best to address the economy's woes, analysts expect Fed Chairman Ben Bernanke to muster a consensus behind a plan to rebalance the Fed's portfolio to push down longer-term interest rates.

Officials hope that by weighting the central bank's bond holdings more heavily toward longer-term debt they can spur mortgage refinancings and push investors into stocks or corporate bonds and away from safe-haven Treasuries.

With a still-growing economy and inflation not far below target levels, U.S. central bank officials are mulling a series of measured easing steps that stop short of an aggressive move like a renewed outright expansion of the Fed's balance sheet.

These are tinkering measures, not the financial bazooka, so to speak, said Carl Riccadonna, senior U.S. economist for Deutsche Bank in New York. If we get to a period where the employment numbers turn negative, then I think there will be much more agreement ... that they will have to do something bolder.

We're certainly not there yet, he said.

Another modest easing step some economists believe the Fed could take on Wednesday would be to trim the 0.25 percent rate it pays banks for excess reserves parked at the central bank. Such a move could make it more attractive for banks to loan money, which could spur the economy.

RIPE TARGET

The Fed cut overnight interest rates to near zero in December 2008 and then bought $2.3 trillion in longer-term bonds to help the struggling economy.

Its latest bond-buying spree fueled harsh criticism that it was risking inflation and weakening the dollar to the detriment of emerging markets, which experienced rapid inflows of hot money.

In the United States, the Fed has provided a ripe target for Republican presidential candidates. One of them, Texas Governor Rick Perry, said any further money printing would be almost treacherous, treasonous. Another, former Massachusetts Governor Mitt Romney, promised to replace Bernanke -- who was originally appointed by President George W. Bush, a Republican -- saying his easy money policies had failed.

In contrast, the International Monetary Fund on Monday urged the Fed to stand ready to provide more stimulus to support the faltering recovery as long as there is no danger of an inflationary mind-set taking hold.

Some analysts estimate the Fed could purchase between $300 billion and $400 billion of bonds in the five-year to 15-year range over the next six months if they simply move to replace maturing Treasuries. Outright sales of shorter-term bonds could be added to accelerate the reshaping of the Fed's holdings without adding to the already bloated $2.8 trillion portfolio.

Financial markets appear to be anticipating Fed efforts to flatten interest rates for longer-term bonds. The difference between yields on two-year and 10-year Treasury securities has narrowed by almost a full percentage point since the end of the Fed's last round of quantitative easing in June, although some of that narrowing may be driven by a flight to safety due to European turmoil and other factors.

Any move to ease further would come over the objections of some Fed officials.

At its most recent meeting in early August, the Fed bolstered its promise to keep rates at rock bottom levels, saying it would do so through at least the middle of 2013. While some policy makers wanted to go even farther, some disapproved of that move and three dissented against the step.

Still, with unemployment at a lofty 9.1 percent, no job growth in August, and reports showing business and consumer confidence withering, a core group of officials, which includes Bernanke, Fed Vice Chair Janet Yellen and New York Federal Reserve Bank President William Dudley, appear solidly behind more stimulus.

As part of its deliberations, the Fed will discuss a wide range of potential steps, such as making public specific targets for unemployment or inflation to make crystal clear to markets that the Fed's ultra-easy money policies are here to stay unless specific improvements occur.

(Additional reporting by Richard Leong in New York; Editing by Neil Stempleman and Leslie Adler)