Economist: Federal Shutdown May Affect Bond Buying

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While a federal shutdown of two weeks or less won’t have a significant impact on the economy, anything longer could affect monetary policy, says a recently released report by the chief economist at Comerica Bank.

The Comerica Regional Economic Update says that the longer the congressional impasse continues, the less likely it is that Fed will begin to reduce its purchase of Treasury bonds and mortgage-backed securities. An earlier edition of the report had assigned a subjective probability of 60 percent to a late October/early November reduction, but Robert Dye, senior vice president and chief economist at Comerica Bank, says that percent is much lower now.

“The Fed opted not to (start tapering) in September, when perhaps they had better timing,” Dye says. “There are arguments for each one of the next four meetings (of the Federal Open Market Committee) not being the best time to start the tapering.”

Scheduled in late October, the next FOMC meeting may be too soon to pull back to reduce buying the bonds. After that, the mid-December meeting may prove to be an inopportune time because of the holiday shopping season. The January meeting will be Chairman Ben Bernanke’s last meeting, and the mid-March gathering is expected to be Janet Yellen’s first meeting heading the FOMC.

Dye says it’s important to note why he and other economists have been so focused on the September-October start for cutting back. “Chairman Bernanke was very consistent in his statements in the summer that he wanted to see the tapering process start at the end of the year. It introduces a lot of uncertainty in the finance market because there was such a strong belief that the Fed would have started that process by now,” he says.

While the Fed’s asset purchases of $85 billion each month has done some good — it adds extra stimulus and works to keep interest rates lower, a positive thing for people buying houses and other interest-sensitive items — it also has it downsides, Dye says.

“(A delay in tapering) continues the distortions to the economy that come with quantitative easing,” Dye says. “We’re in the third round of an extraordinary policy … When do we start to see a more regular monetary policy?”

The report also notes that if Congress doesn’t agree to lift the debt limit by around Oct. 17, there is a significant risk of technical default on some interest payments on Treasury bonds. “A default of any kind would likely result in a downgrade of U.S. Treasury bonds by ratings agencies, pushing bond prices down and interest rates up,” says the report.

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