The Federal Reserve should consider delaying the end of its bond purchase program to halt a decline in inflation expectations, said St. Louis Federal Reserve Bank President James Bullard.

Speaking in an interview today with Bloomberg News in Washington, Bullard said U.S. economic fundamentals remain strong, and he blamed recent financial-market turmoil on downgrades in the outlook for Europe.

“Inflation expectations are declining in the U.S.,” he said. “That’s an important consideration for a central bank. And for that reason I think that a logical policy response at this juncture may be to delay the end of the QE.”

Bullard is the first Fed official to publicly suggest the central bank should extend its program of quantitative easing when policy makers meet later this month. U.S. stocks pared losses and Treasuries declined on expectations the Fed will take action to insulate the U.S. from global economic weakness.

“We are watching and we’re ready and we are willing to do things to defend our inflation target,” Bullard said.

Fed officials are scheduled to next gather on Oct. 28-29 and have said they expect to end asset purchases after that meeting. The program has already been wound down to combined monthly purchases of $15 billion of Treasuries and mortgage backed securities, from $85 billion in December 2012.

“Fifteen billion by itself is not that consequential,” Bullard said. “But what is consequential is committee intentions on future QE, and we have certainly seen through the taper tantrum how important those can be.”

David Fuller's view

While Bullard’s statement is somewhat of a surprise, his suggestion to temporarily delay the end of QE under the current circumstances seems reasonable to me.  However, whatever the Fed decides to do this month, it will remain a ‘damned if you do and damned if you don’t’ situation. 

I do not expect a unanimous decision, but I do think it would cushion near-term downward risk somewhat.  More importantly, a temporary delay in the ending of QE might allow a more orderly unwinding of excessive leverage (margin debt), (hat tip to Doug Short for this important chart which I have also shown previously). 

See also Eoin’s lead item on Wednesday: “A review of important ratios”.)