Fed could boost US economy with Operation Twist stimulus, experts claim

http://www.guardian.co.uk/business/2012/jun/18/fed-us-economy-operation-twist

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The Federal Reserve could step in with a new round of Operation Twist this week to bolster the fragile American recovery as Europe's woes continue to rattle the US economy, experts believe.

Fed chairman Ben Bernanke and the Federal Open Markets Committee (FOMC) meet Tuesday and Wednesday this week, amid fresh developments in the eurozone crisis and signs that the US economy is picking up.

Analysts predict that while the FOMC will stop short of a major intervention in the form of a third round of quantitative easing, they are more likely to take the smaller scale option of Operation Twist.

This involves the Fed selling medium-term bonds, and using the proceeds to buy longer-term bonds — such as 10-year treasuries. In theory, such a move drives down the interest rate on 10-year bonds, taking down interest rates across the board. Mortgages are tied to 10-year Tteasury rate and the move should bring down home loan rates.

The housing market has been a major drag on US recovery, but there have been signs that prices have bottomed out ,and on Monday the National Association of Home Builders said its housing market index, a poll of builders' confidence, had reached its highest level in more than five years.

The Fed is facing calls to act as events in the eurozone continue to threaten the US economy.

In Greece, the newly elected New Democracy party is currently attempting to forge a coalition to govern. The party is supportive of Europe's bailout plan for Greece and its attached austerity measures. Its election allayed fears of an imminent escalation in the eurozone crisis.

Larger worries remain, however, and Spanish bond yields spiked on Monday as the focus of investors' fears moved on, while the future price of a barrel of oil dropped as traders bet growth was slowing.

Phil Flynn, an analyst at Price Futures Group in Chicago, said oil prices were falling in part as a reaction to the Greek news. "The right party got in but that probably means stimulus is unlikely to happen," he said. He said that traders were betting that without further stimulus, growth is likely to remain low and with it demand for oil.

Bernanke has spoken of his fears that "headwinds" from Europe's economic crisis could stifle American's fragile recovery. Some had been hoping for a third round of quantitative easing (QE3), the Fed's massive bond-buying stimulus package. Such a big move could spark a political firestorm so close to the US election.

The EU's European Council meets at the end of June at what analysts said could well be a turning point for policy makers on both sides of the Atlantic. But they said this weekend's news from Greece and continuing signs that the US is still recovering, albeit slowly, made Operation Twist more likely than any big move this week.

"They can always call another meeting should the situation change dramatically," said Paul Ashworth, chief US economist of Capital Economics.

Gus Faucher, senior macroeconomist at PNC Bank, said the US treasury could buy as much as $200bn in long-term treasuries in a move that could stimulate more home buying. "The softness in the US economy is still a concern," he said. Faucher said that while Europe's woes were likely to have a negative impact on US economy, the news from Greece was "pretty much as expected" and unlikely to add more pressure on the FOMC.

But there are still major problems ahead. Last week Nouriel Roubini, professor at New York University's Stern School of Business and chairman of Roubini Global Economics, warned that a break-up of the eurozone was still possible.

In a column, Roubini, sometimes known as Dr Doom, wrote the eurozone "may require not just an international bailout of banks (as recently in Spain), but also a full sovereign bailout at a time when eurozone and international firewalls are insufficient to the task of backstopping both Spain and Italy. As a result, disorderly breakup of the eurozone remains possible."

Jacob Kirkegaard, research fellow at the Peterson Institute For International Economics, said there were serious issues ahead but that the election news from Europe was a positive sign.

"This pervasive market negativity is built on the premise that the Euro is bound to collapse. Why? I don't think that's substantiated by the evidence," he said. He said markets had wobbled but not collapsed and that the Euro remained relatively strong against the dollar.

Kirkegaard said he expected greater fiscal unity to come out of the European summit. "Markets want this sorted out over a six month time frame, but that is not how this is going to happen," he said. "Once you adopt a realistic timeframe I don't think we are doing too badly."