By Steven K. Beckner

(MNI) – The duelling objectives of the “dual mandate” are likely to
keep the Federal Reserve on hold when its policymaking Federal Open
Market Committee meets next week.

But “on hold” very probably means maintaining a very easy monetary
policy with a tacit easing bias. And, since the Fed has already cut the
federal funds rate as much as possible and gone about as far as it can
realistically go in communicating its intention to keep that rate
“exceptionally low” for at least another two and a half years, it would
almost have to be called a quantitative easing bias.

The two-day meeting will have more significance than usual. For
only the second time since the FOMC began the process in January,
members will be making federal funds rate forecasts and funds rate hike
predictions along with their updated economic forecasts as part of the
quarterly Summary of Economic Projections (SEP) exercise.

Also, as is customary, Fed Chairman Ben Bernanke will be holding a
post-FOMC news conference, where he will have a chance to elucidate the
policy statement and forecasts.

He seems likely to keep alive doubts about the strength and
sustainability of labor market improvements, reassert his confident
belief that inflation will subside from temporarily elevated levels and
thereby leave the door open to a third round of quantitative easing.

Whether Bernanke is willing to be as explicit about his
preparedness to resort to QE3 as he was in his Jan. 25 press conference
remains to be seen. But, if his more recent public comments are any
indication, he will be less blunt.

While most policymakers agree on the need to keep rates very low
“at least through late 2014,” providing additional stimulus is another
matter.

Comments last week by Atlanta Fed President Dennis Lockhart may be
indicative. Often called a “bellwether,” the FOMC voter said he is
“reticent” about doing more bond buying, saying QE3 is “something to
hold in reserve for such a development” in case there were to be “a very
dramatic negative change of direction of the economy.”

There is a certain amount of inertia, not to say reluctance, about
further expanding the Fed’s $2.8 trillion balance sheet.

An actual QE3 would probably only be launched if there is a
combination of continued disappointing job gains and evidence that the
recent bulge in consumer prices is indeed transitory. A wildcard that
could tip the balance in favor of more large-scale asset purchases might
be some shock, such as an Iran-related oil spike or a reintensified Euro
area crisis, that threatened to undermine growth, destabilize financial
markets and generate deflationary forces.

In short, the benefits must be seen to exceed the costs, the most
important of which is the difficulty of shrinking the balance sheet the
larger it gets.

Bernanke and most of his FOMC colleagues have justified past easing
measures by maintaining that both sides of the dual mandate point in the
same direction — namely that unemployment was too high and inflation
too low or threatening to be too low.

Not all of Bernanke’s fellow policymakers have agreed with the FOMC
majority’s policy calculus. For example, Philadelphia Fed President
Charles Plosser, among others, complained that it made no sense to adopt
easing measures last August and September when unemployment was lower
and inflation higher than in November 2010, when the $600 billion QE2
was launched.

In any case, recent inflation and employment data have been
diverging, making it harder to justify QE3. Although the unemployment
rate dipped another tenth to 8.2% in March, due in good part to reduced
labor force participation, the Labor Department reported that non-farm
payrolls rose just 120,000 — far short of the expected 200,000 and even
further below the 246,000 average of the prior three months. Prior
months’ payrolls were revised up, but only by 4,000. And hours worked
fell 0.2%.

The relatively weak jobs data, though only one month’s numbers,
seemed to confirm the Okun’s Law-related doubts Bernanke had been
expressing about the ability to sustain 200,000-plus payroll gains and
unemployment reductions without faster economic growth.

The labor market data caused some rethinking about the odds of QE3
in financial markets after the minutes of the March 13 FOMC meeting
showed the number of members thinking additional asset purchases might
be warranted dwindling to “a couple.” Wall Street hopes for more
monetary stimulus were revived somewhat.

But inflation data have not been cooperating with financial market
participants who are eager for QE3.

A week after releasing those downbeat March employment numbers, the
Labor Department reported that the consumer price index rose 0.3% last
month. The core CPI, excluding food and energy, rose 0.2% — up from
0.1% in February. Though much as expected, the price data seemed to
confirm that rising oil and gasoline prices were not only pushing up
overall prices but generating some pass-through to core inflation.

On a year-over-year basis, the CPI was up 2.7% and the core CPI
2.3% — well above the 2% target which the FOMC formally announced in
January. Annualizing the March figures yields a much higher rate of
inflation.

Although the FOMC on March 13 predicted that inflation will only
rise “temporarily,” then “run at or below” 2%, it will be hard for
Bernanke and company to inject more money into the economy until
inflation does, in fact, retreat.

In any case, there is arguably no pressing need so long as the Fed
is continuing its $400 billion “maturity extension” program, by which
the Fed has been exerting downward pressure on long-term interest rates
through sales of short-term Treasury securities in its portfolio to
finance purchases of long-term securities.

But looming in the not-too-distant future is the scheduled June 30
completion of “Operation Twist.”

And, while inflation is running at uncomfortable levels for now,
disturbing indications continue to come which suggest that the recovery
remains too sluggish to significantly increase low rates of labor and
other resource utilization or “slack.”

In the minds of most policymakers that “slack,” together with
“anchored” inflation expectations, virtually guarantee that inflation
won’t gain a lasting foothold.

The Fed’s March industrial production report showed factory
capacity utilization dipping from 78.0% to 77.8% as manufacturing output
dropped a surprising two tenths. Meanwhile, housing starts dropped a
worse-than-expected 5.8%.

Fed Vice Chairman Janet Yellen said last week that slack “will
likely remain substantial for quite some time,” and GDP growth “will be
sufficient to lower unemployment only gradually … in part because
substantial headwinds continue to restrain the recovery.”

Yellen said “the substantial slack in the labor market has
restrained inflation by holding down labor costs” and added that
“longer-term inflation expectations have been remarkably stable.” She
predicted that, after a “temporary” rise, inflation “will run at or
below” the Fed’s 2% target and concluded that “a highly accommodative
policy stance (is) appropriate in present circumstances.”

Similarly, New York Fed President William Dudley, the FOMC vice
chairman, said “real economic activity has yet to be strong enough on a
sustained basis to make a big dent in the overall amount of slack in the
U.S. economy” and said inflation has likely “peaked and we expect it to
begin to decline later this year.”

Bernanke is known to share the view that high unemployment will
prevent any lasting inflation rise.

And so it would be surprising if the FOMC does not reaffirm its
expectation that the funds rate will stay near zero “at least through
late 2014,” although there may well be a push from Plosser and others to
substitute a “reaction function” for a calendar date.

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** MNI **

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