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Bullard: Don't Think FOMC to Extend Operation Twist; May Replace

ST. LOUIS, Mo. - St. Louis Federal Reserve Bank President James Bullard Thursday night said he doubted Fed policymakers will prolong the Maturity Extension Program or "Operation Twist" when it expires at the end of December, but said they could "replace" it to some extent.

Bullard, who will be a voting member of the Fed's policymaking Federal Open Market Committee next year, said the FOMC could sell securities dated longer than three years to finance purchases of long-term securities, but said that would be "problematic."

If the FOMC instead decides to replace "Operation Twist" with enlarged bond purchases in its third quantitative easing program, he indicated he would be against replacing it on a "one-for-one" or dollar-for-dollar basis.

Bullard said the Fed's monetary policy stance is already "pretty easy" -- too easy, he suggested, for an economy that is improving amid diminished headwinds from Europe and likely headed toward 3.5% growth next year.

Under Operation Twist the Fed is buying $45 billion per month of long-term Treasuries, financed by sales of three-year-and-less Treasuries. But that is due to expire on Dec. 31. Meanwhile, the Fed is buying $40 billion per month of mortgage backed securities, financed by the creation of new reserves, until the labor market improves "substantially."

Bullard, talking to reporters following an address at Washington University, said "it's unlikely we'd extend Operation Twist, because there's only so much balance sheet we can really use to sell short and buy long."

Rather, the FOMC is "going to have to make a decision to replace that with something else and what to replace it with," he said, adding that "one of the advantages of the approach we took with QE3 is that we can adjust (the amount of asset purchases) to make up for any perceived tightening."

Expanding QE3 is "definitely an option on the table," he said, but "I wouldn't want to prejudge."

Asked by MNI whether he would support replacing the expiring $45 billion in Twist purchases on a one-for-one basis, Bullard indicated he would not.

"To me personally that sounds like easier policy," he replied. "If you just wanted to replace Twist ... you wouldn't have to go to a one-for-one replacement."

But he said, "We'll have to see where the decision comes down."

Bullard, in his earlier speech, had cited research showing that monetary policy is already "substantially easier" than Taylor-type monetary policy rules recommend.

MNI also asked Bullard about the possibility of the Fed selling 3- to 6-year securities to finance long-term Treasuries.

He said that "is an option," but called it "problematic about the kind of effects that's supposed to have."

Bullard suggested that additional monetary stimulus is not likely to be needed. He said the economy is improving, particularly in the housing sector, as "headwinds are dissipating." He projected 3.5% growth next year, with the unemployment rate falling to 7.2% by year-end.

He had a caveat, though. If the "fiscal cliff" is not resolved, he warned, it could do great damage to the economy, which the Fed could not offset.

Earlier, in response to audience questions, Bullard had warned that the Fed's extended zero interest rate policy is causing the kind of risk taking that could lead to a new asset bubble.

But he told reporters that, although land prices have been soaring, so far he has not seen evidence of a new bubble. It is important, however, that the Fed "keep an eye on that," he said.

"If you're ever going to have a bubble it's going to be in a low interest rate environment," he said.

In other comments, Bullard said, "I don't really see increased tolerance for inflation" on the FOMC. He said it's just that "the committee is concerned about labor markets. They're not improving as fast as we would like, but they are improving."

 

Market News International is a real-time global news service for fixed-income and foreign exchange market professionals. See www.marketnews.com.

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