While the Fed’s tapering plans may hold secondary importance this morning when the world – if not so much markets – focus on the calamity in Afghanistan, this morning the WSJ’s Fed whisperer Nick Timiraos (who replaced Jon Hilsenrath as the preferred mouthpiece for the central bank) writes that Fed officials are nearing agreement on scaling back their easy money policies in about three months if the economic recovery continues, with some pushing to end their asset-purchase program by the middle of next year.
At their July 27-28 meeting, FOMC members deliberated on two important questions: when to start paring their monthly purchases of $80 billion in Treasury securities and $40 billion in mortgage securities, and how quickly to reduce, or taper, them. The Fed is set to release on Wednesday minutes of the meeting that could provide further clues about those discussions.
Citing several Fed officials, recent interviews and public statements, Timiraos notes that several Fed officials have advocated for this accelerated timetable, which would enable them to raise interest rates sooner than currently anticipated if the economy makes rapid progress toward their goals. Last December, the Fed said it would continue the current pace of bond purchases until officials concluded they had achieved “substantial further progress” toward their goals of 2% average inflation and robust employment. More recently, Powell made it clear that the key hurdle is employment with the Fed willing to red inflation run red hot.
Here are key highlights from the original article (link):
Boston Fed President Eric Rosengren said in an interview he expected to see by the Sept. 21-22 meeting enough job growth to meet the criteria for reducing bond purchases. “That would set up some time this fall a possible tapering that is dependent on the Delta variant and other variants not slowing down the labor market substantially,“ he said in an interview last week.
Rosengren said he hopes that if strong economic growth continues, “we’re done with the tapering program…towards the middle of next year.”
“If you can’t get housing materials and you can’t get construction workers to come back on site, but we do increase demand for housing, then it doesn’t do much for our employment mandate — but it does increase housing prices more than it otherwise would,” he said.
Dallas Fed President Robert Kaplan agreed. “These purchases are very well designed to stimulate demand, but we don’t have a demand problem,” he said in an interview. “In the aftermath of the Great Recession, we did. So I don’t want to use the playbook from 2009 to 2013.”
Kaplan said by reducing asset purchases sooner, the Fed might be able to wait longer before it has to raise interest rates. “By getting a more appropriate stance of monetary policy now or soon, it might actually allow you to be more flexible and be more patient on how you adjust the federal-funds rate down the road.”
San Francisco Fed President Mary Daly also said in an interview last week she thinks the economy should support “beginning to taper later this year, or maybe next.” Labor markets are “really strong — getting stronger.”
St. Louis Fed President James Bullard said he wants to start paring assets in October and conclude the program by March, reducing the purchases of Treasurys by $20 billion a month and mortgage bonds by $10 billion a month.
“I don’t want to have to move too rapidly [to raise rates] because it can be very disruptive, so I think that the pace I’m suggesting would give us a lot more optionality in 2022 if we needed to use it.
At the same time, other officials have argued for more patience. Fed governor and the rumored replacement of Powell, Lael Brainard, indicated last month she wanted to see September hiring data, which won’t be available until early October, before deciding. That would hold off any tapering until no sooner than the Fed’s Nov. 2-3 meeting. Chicago Fed President Charles Evans and resident uberdove didn’t say how soon he thought the Fed would need to wind down its purchases. He expects inflation to fall back to 2% by the end of next year, which would argue for less urgency to withdraw monetary stimulus.
“My own outlook is, we’re gonna be more challenged in getting inflation to confidently stay up in the 2% or 2.1% or 2.2%” range, he said. “If others had more confidence that inflation was going to be higher on a sustainable basis, then that…quicker tapering could be the right path.”
Back in 2013, the Fed wound down its previous bond-buying program very gradually, reducing its purchases over the course of 10 months. That said, when it announced that it would soon start that process, the economy was weaker, with higher unemployment and low inflation.
Officials had another reason for caution back then because they were stunned by a surge in long-term Treasury yields, the so-called “taper tantrum,” that occurred in the middle of 2013, after then-Chair Ben Bernanke suggested they might soon reduce their asset purchases.
According to Timiraos, “this time is different” as the Fed now finds itself in a very different position. The economy is growing rapidly. Unemployment is much lower, at 5.4% in July. Inflation is much hotter. And bond yields have tumbled this year even as the central bank has discussed plans to reduce bond purchases.
In a note from Morgan Stanley’s chief economist Ellen Zentner, the bank said it expects the Fed to reduce the pace of its asset purchases beginning in Jan-22 by $10bn UST/$5bn MBS per meeting, but mused on the possibility that it is wrong and had its strategists explore the market implications of variations on this baseline and recommend trading strategies under each scenario (more on this in a latter post). As the table below shows, MS – like most other banks – expect that it will take the Fed about 10 month to fully taper its $120BN in combined TSY/MBS purchases per month to zero.
For what it’s worth, the market expectations of the first full rate hike have barely budged, with the first rate hike – which is expected to come well after tapering is concluded – still expected not before the start of 2022.
Finally, we can’t help but remind readers of what BofA said two months ago when it correctly predicted that the Fed taper will stop the moment the S&P drops 10%, which explains the full-scale campaign to make it appear as if the taper is not only priced in but will be bullish for the market.