Talk of Deflation Possible as Fed Meets Tuesday
Poor July unemployment data and continued concerns about the financial recovery should prompt the Fed to keep interest rates at the current 0%-0.25% during its meeting Tuesday in Washington. But many analysts wonder what more can the Fed do. Are there any magic bullets left in the gun to stave off deflation? Issues arising from the current zero interest-rate policy (ZIRP) also are expected to be addressed by the Federal Open Market Committee when it provides its quarterly rate decision and statement Tuesday afternoon. Dropping the rate to 0% in December 2008 was supposed to spur increased lending by banks. The once seemingly unreal but now looming possibility of America heading to deflation also may be addressed by the FOMC. "I find it interesting how rapid the talk of deflation has come back on the table in just the last few weeks," said Bert Ely, head of an eponymous financial institutions and monetary policy consulting firm in Alexandria, Va. "I think what people are going to look for from the statement is to what extent the Fed buys into all this deflation anxiety." The Wall Street Journal reported Monday that when Federal Reserve chairman Ben Bernanke was a professor at Princeton in the '90s, he urged the Bank of Japan to set an objective of 3% to 4% inflation, as the Asian nation spiraled into deflation. The Journal article said the reason for doing such was with zero interest-rate policy (ZIRP) "rising inflation would mean that the real cost of borrowing, which is nominal interest rates minus inflation, would be falling. In theory that would spur demand." But Bernanke has spurned that notion as Fed chairman, according to the WSJ, because the U.S. doesn't have deflation yet. Paul Miller, managing director and group head of financial services research at FBR Capital Markets, said he anticipates the Fed will keep rates where they're at and say they will be continuing to monitor the situation. "They will probably talk about deflation being contained because they don't want people talking about deflation as that can become deflationary in its own right," Miller said. "I think it'll be status quo, as they'll keep rates low and the government will continue to subsidize the mortgage rates." FOMC members also may consider ways to reinvest proceeds of maturing mortgage-backed securities held by the US central bank during Tuesday's meeting. It may be a small step, but it could help the Fed's balance sheet from contracting. And with ZIRP and billions of stimulus money failing to stimulate legitimate recovery, reinvesting the funds may be a necessity to grow the nation's economy. Friday's unemployment figures showed little hope that there's a true economic recovery taking root as another 131,000 jobs were lost in July. About 143,000 temporary Census jobs were lopped off the federal payroll and an additional 59,000 governmental positions were lost last month. Some 71,000 private-sector jobs were added during the month but the overall unemployment rate remained at 9.5%. Another troubling sign was a 5,600 drop in temp jobs, often viewed as a leading indicator of the entire labor market, after nine months of consecutive growth. Write to Jason Philyaw.