By Steven K. Beckner

(MNI) – Although no new monetary policy measures issued from it,
this week’s Federal Open Market Committee meeting was something of a
milestone.

It was the last time Federal Reserve policymakers met before the
Nov. 6 presidential election. And, depending on the outcome of that
election, it could be the next to last FOMC meeting of the Obama
administration and the first to take place under president-elect Mitt
Romney.

Following its final meeting of 2012 on Dec. 12-13, the FOMC isn’t
scheduled to meet again until nine days after the inauguration of either
a reelected President Barack Obama or a new president Romney.

The election outcome could have important bearing on the leadership
of the Fed in 2013 and beyond.

In any case, the December meeting is not to be overlooked. It
promises to be much more significant than December FOMC gatherings have
traditionally been.

That is because the second phase of the Fed’s Maturity Extension
Program or “Operation Twist,” under which the Fed has been selling
short-term and buying long-term Treasury securities to lower long-term
interest rates, is due to expire on Dec. 31.

At that time, monthly asset purchases will abruptly shrink from $85
billion to $40 billion — the amount of mortgage-backed securities the
Fed is buying in its third round of “quantitative easing.” The FOMC will
have to decide whether it needs to adjust the size of QE3 to offset the
sudden drop-off of aggregate Fed asset purchases.

San Francisco Fed President John Williams told MNI not long ago he
does not expect any major “cliff effects” on yields when the Operation
Twist purchases end, but indicated he’d be prepared to increase the size
of QE3 and possibly move into Treasuries if there isn’t “substantial”
improvement in labor markets.

Others, notably Chicago Fed President Charles Evans, have been even
more blunt in saying the Fed should augment QE3 to offset the end of
Twist.

The FOMC gave itself leeway to adjust QE3 in its Sept. 13 policy
statement.

“If the outlook for the labor market does not improve
substantially, the Committee will continue its purchases of agency
mortgage-backed securities, undertake additional asset purchases, and
employ its other policy tools as appropriate until such improvement is
achieved in a context of price stability.”

Bernanke said the amount and the composition will be adjusted in
response to changing economic conditions. “If the economy is weaker,
we’ll do more,” he said in his post-FOMC press conference.

The minutes of the September FOMC meeting emphasized that, by not
announcing a predetermined amount of asset purchases over a set period
of time as in QE1 and QE2, the FOMC is taking a “flexible approach” that
will allow it “to tailor its policy response over time to incoming
information.”

Conceivably, the FOMC could wait until its January meeting to
decide what to do, but it seems more likely a decision will be made at
the Dec. 12-13 meeting, at which members will put together a fresh set
of economic projections and Bernanke will hold another news conference.

Whether the FOMC will judge that there has been sufficient
improvement in the economy and in labor markets by the time of the
December meeting is highly uncertain.

The Commerce Department estimated Friday that expansion of the
gross domestic product accelerated from 1.3% in the second quarter to
2.0% in the third quarter. And there have been signs that GDP has
continued to grow by at least 2% in the fourth quarter.

But the Fed regards 2% growth as the bare minimum needed to keep
unemployment from rising. The FOMC’s “longer run” growth projection is
2.3% to 2.5%.

And there has been insufficient job creation to make real inroads
into high unemployment.

More than three years after the formal end of the recession in June
2009, as determined by the National Bureau of Economic Research, the
unemployment rate still stands far above the FOMC’s 5.2% to 6% “longer
run” unemployment projection.

Although private payrolls have risen by some 4.5 million over the
past two and a half years, that is still only about half of the jobs
lost during the recession. About 5 million workers have been unemployed
for six months or more.

The unemployment rate dipped three-tenths in September to a
44-month low of 7.8%, but not for the best of reasons. There was a
582,000 upsurge in the number of “part-time workers for economic
reasons” — people who’d rather have a full-time job but couldn’t find
one. Factoring in discouraged and involuntarily temporary and part-time
workers, the “U-6″ unemployment rate stands at 14.7%.

Non-farm payrolls still rose by 114,000 in September, but even with
a 86,000 upward revision to prior months (mostly government jobs),
payroll gains have averaged an anemic 106,000 per month over the past
six months. That’s barely more than the minimum needed, at current rates
of labor force participation, to absorb new entrants into the labor
force.

Not surprisingly, Bernanke has said, “The stagnation of the labor
market in particular is a grave concern.”

It would be surprising to see a lot of improvement — “substantial
improvement” — in what little remains of this year, especially
considering worries about the “fiscal cliff” which looms in January. Fed
officials are also concerned about downside risks from Europe and China
and so forth.

So the FOMC may well decide in December to increase monthly QE3
purchases from $40 billion to something higher, with some of the extra
perhaps going into Treasuries, to offset the expiration of Operation
Twist and further insulate the economy against those headwinds.

If the fiscal cliff of automatic tax hikes and spending cuts is not
smoothly resolved and/or if the federal debt ceiling is not raised in a
timely way, there could be major financial market disruption and
budgetary contraction.

The Congressional Budget Office and the International Monetary Fund
have warned that could trigger a new recession, and Bernanke has said
there is nothing the Fed could do to offset the impact. So the FOMC
could decide in December that it needs to take out additional insurance,
knowing it could always reduce QE3 purchases later once the fiscal
impasse has been resolved.

The other issue on the horizon is the leadership of the Fed.

If Obama is reelected, it is expected that Bernanke would stay on
and probably be reappointed to a third term, when his current term
expires in early 2014 — assuming he wants it, which is not certain.
Vice Chairman Janet Yellen could ultimately succeed Bernanke under a
second Obama administration,

On the other hand, a Romney victory might mean the end of
Bernanke’s tenure. Romney himself has said he wants to replace Bernanke.

However, cooler heads may prevail in that instance. Columbia
University Professor Glenn Hubbard, Romney’s top economic advisor and a
potential Bernanke successor, has told MNI that Bernanke should be
considered for reappointment.

Romney might want to listen to that advice, knowing a Bernanke
exodus would likely hurt market confidence at a very inopportune time.

In a possible scenario, one could imagine that, on an initial visit
to the White House in a Romney administration, Bernanke might offer to
resign immediately, but be told by Romney that he wants him to serve out
his term.

Bernanke has kept to himself his personal desires, although there
have been unconfirmed reports that the former Princeton University
Professor does not want a third term.

It has been speculated that, under a Romney presidency, a
reconstituted Fed would make a dramatic shift toward a tighter monetary
policy. But it seems more likely there would be considerable continuity
for the foreseeable future.

** MNI **

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