WASHINGTON – The Federal Reserve is being engulfed by the one thing it tries to prevent: uncertainty.
Will the Fed take its first step Wednesday toward reducing the extraordinary stimulus it’s given the U.S. economy?
Will its eventual pullback jolt the financial markets?
Who will fill several vacancies on the Fed’s policy board next year?
And, with Lawrence Summers’ withdrawal from consideration, who will lead the Fed once Ben Bernanke’s term expires in January, ending one of the most tumultuous chapters in the Fed’s 100-year history?
Uncertainty tends to rattle investors. Starting this week, the Fed may begin to supply the answers the financial markets are looking for.
Here’s a look at the various uncertainties the central bank faces:
TO TAPER OR NOT
Though hiring and economic growth in the U.S. remain soft, the Fed is widely expected this week to slow the pace of its bond purchases. Its purchases of Treasury and mortgage bonds have been designed to keep long-term loan rates low to get people to borrow and spend and invest in the stock market.
Most economists expect the Fed’s initial move to be small – a reduction in monthly purchases from $85 billion to $75 billion.
One reason: The Fed for months has been preparing markets for such a move. Fed officials wouldn’t likely want to raise further uncertainty by failing to meet the very expectations they had raised.
Another factor: Some Fed officials don’t think the bond purchases are doing much good anymore. And they feel that by continuing to flood the financial system with cash, the Fed might be raising the risks of high inflation or dangerous bubbles in assets like stocks or real estate.
Some had once expected a sharper first reduction in the Fed’s purchases of around $20 billion a month. But that was before the government said that job growth was only modest in August and that employers added many fewer jobs in June and July than previously thought.
Investors’ response to a pullback in purchases is expected to be mild if the Fed announces a reduction of only around $10 billion a month. That’s especially true if it balances its action by underscoring its commitment to keep short-term interest rates low well into the future.
The Fed has kept its benchmark for short-term rates at a record low near zero since December 2008. And it has said it expects to keep it there at least until the unemployment rate falls to 6.5 percent – as long as the inflation outlook remains mild.
The unemployment rate is now 7.3 percent. Many economists do not expect it to reach 6.5 percent until late 2014 or early 2015.
Even then, Bernanke has said the Fed might decide to keep its short-term rate at a record low, especially if unemployment has dropped because more people have stopped looking for work. The government doesn’t count people as unemployed once they stop looking for a job.
To stress its commitment to keep short-term rates low as long as necessary, the Fed may tweak the language in the statement it will issue Wednesday. It might say that a decline in inflation would cause its benchmark rate to remain near zero longer than expected. One Fed official has also suggested lowering the unemployment threshold for any short-term rate increase to 5.5 percent from 6.5 percent.
Any such changes would give investors more assurance that short-term rates will remain low for many more months. All things considered, many economists don’t expect the first Fed rate hike to occur before 2015.
FED COMMITTEE VACANCIES
Bernanke’s chair is one of several that will need to be filled in coming months. In fact, the Fed’s policy panel will have only 10 voting members at this week’s meeting instead of the normal 12. One board member, Elizabeth Duke, left in August. Another, Sarah Bloom Raskin, has been nominated by Obama for the No. 2 job at Treasury and won’t take part in the meeting.
In addition, the term of a third board member, Jerome Powell, expires in January. And a fourth, Jeremy Stein, must decide whether to remain at the Fed or return to his teaching post at Harvard by May.
Also, among the 12 regional Fed presidents, Sandra Pianalto, head of the Cleveland Fed, has announced that she will step down early next year.
Obama hasn’t said publicly whom he might choose to fill those vacancies. Some published reports have suggested that Lael Brainard, Treasury’s undersecretary for international affairs, is under consideration for one of the open board seats.
The many vacancies are sure to raise questions about the Fed’s future course of policy.
Bernanke’s second four-year term as chairman expires Jan. 31, and he’s made clear he isn’t interested in another term. The speculation over who will succeed him has been Washington’s favorite guessing game this summer. The two leading candidates had been former Treasury Secretary Lawrence Summers and current Fed Vice Chair Janet Yellen.
But in a surprise, Summers announced Sunday in a letter to President Barack Obama that he wished to remove himself from consideration for the job. Financial markets rallied Monday. Many investors had feared that if Obama chose Summers, who was thought to be his first choice, it could lead to a protracted Senate confirmation battle and perhaps raise doubts about the Fed’s commitment to low rates.
About one-third of Senate Democrats had written to Obama, urging him to pick Yellen. Summers was opposed by liberals for his support as Treasury secretary of bank deregulation measures seen as contributing to the 2008 financial crisis.
Critics also felt that Summers’ abrasive management style wouldn’t work in the Fed’s typically collegial atmosphere. A Fed chairman represents one of 12 votes on policy and must build consensus among a diverse group of board members and regional bank presidents with sometimes conflicting views.
Yellen, the highly respected No. 2 official at the Fed, is seen as likely to get the nomination now. But analysts said a dark horse candidate can’t be ruled out. One could be former Treasury Secretary Timothy Geithner, who is personally close to Obama. Yet Geithner has said repeatedly that he isn’t interested in the Fed job.
Yellen’s supporters have argued that with so many vacancies to fill, her experience on the Fed board as vice chair and before that as president of the Fed’s San Francisco regional bank, would be a crucial asset for the Fed’s chairmanship.