Fed's cues on rates more critical than bond buys: Fed study

By Ann Saphir

SAN FRANCISCO (Reuters) - For investors trying to pinpoint when the Federal Reserve will likely end its massive bond-buying program, the message from researchers at a pair of influential regional Fed banks was clear: don't bother.

More crucial in terms of monetary policy's impact on U.S. growth and inflation will be signals from the U.S. central bank on when it will start to raise short-term interest rates from their current near-zero level, economists at the San Francisco Fed and the New York Fed wrote in the latest issue of the San Francisco Fed's Economic Letter published on Monday.

The Fed's bond-buying programs have given a moderate boost to the economy, but they would have far less impact without the Fed's simultaneous promise to keep rates low, they showed.

The finding, they said, goes not only for past rounds of quantitative easing, but also for the Fed's current and third round, known as QE3.

"Our analysis suggests that communication about when the Fed will begin to raise the federal funds rate from its near-zero level will be more important than signals about the precise timing of the end of QE3," San Francisco Fed senior economist Vasco Curdia and New York Fed senior economist Andrea Ferrero wrote.

Bond yields surged and stocks tanked in June after Fed Chairman Ben Bernanke said the central bank could begin to pare back its $85 billion in monthly asset purchases later this year, ending in the middle of next year when the unemployment rate is likely to be around 7 percent.

Investors were apparently taken by surprise that the central bank intended to wean markets of its program so soon, Fed officials have since said, expressing their own surprise at the strength of the reaction.

Policymakers have since moved, with some success, to tamp down the view that reducing the bond-buying does not bring the Fed near to raising rates.

And even the most hawkish policymakers, the ones who most want to end QE3, are at pains to emphasize that ending bond buys does not mean the Fed has backed away from its promise to keep rates low until the unemployment rate falls to at least 6.5 percent, as long as the inflation outlook stays benign.

The research published Monday shows why such a promise is so important.

The Fed's second round of asset purchases, totaling $600 billion, added about 0.13 percentage point to GDP growth and about 0.03 percentage point to inflation, the analysis showed.

Without the Fed's promise to keep rates low, the researchers said, QE2 would have added just 0.04 percentage point to GDP and 0.02 percentage point to inflation.

"Forward guidance is essential for quantitative easing to be effective," the economists wrote.

That sentiment is in line with the views of a number of Fed officials who have suggested that the Fed's main policy tool is, and should be, rates rather than bond purchases.

(Reporting by Ann Saphir; Editing by Chizu Nomiyama)

Source: http://news.yahoo.com/feds-cues-rates-more-critical-bond-buys-fed-170541070.html

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