It’s not yet a done deal, but it seems increasingly likely the Federal Reserve will begin scaling back its massive monthly bond purchases before long — perhaps in September.
But whether that is just the first step in a continuous process of policy firming, ultimately leading to rate hikes and balance sheet shrinkage, remains in doubt.
That’s because the economic recovery remains in doubt.
Minutes of the Fed’s June 18-19 Federal Open Market Committee (FOMC) meeting show divisions and uncertainties — with half saying “quantitative easing” should end late this year and others wanting the FOMC to await better jobs numbers and dial back bond buying more gradually, continuing it into next year.
The minutes don’t alter the fact, however, that there has been a considerable change in majority FOMC sentiment in recent months, culminating in the Committee’s June 19 determination that the economic outlook has brightened, that downside risks have “diminished” and that below-target inflation is likely to prove “transitory.”
Nor do the ostensible contradictions in the minutes change the fact that Fed Chairman Ben Bernanke, at the FOMC’s behest, conveyed the majority’s view that the Fed may well start tapering its $85 billion per month purchases of longer term Treasury and agency mortgage-backed securities “later this year” and perhaps end them by mid-2014, assuming the unemployment rate has fallen to about 7%.
Although various Fed officials subsequently tried to soothe financial markets after stocks plunged and bond yields soared, none really contradicted that basic message.
To be sure, the message was misinterpreted in some quarters. Bernanke was careful to say that any reduction of bond purchases would be contingent upon continued improvement in the labor market outlook. And he said “one of the preconditions for the policy path that I described is that inflation begin at least gradually to return toward our 2% objective.”
Bernanke stressed again and again that the Fed is not contemplating a tightening of monetary policy, only a reduction in the pace at which it is injecting stimulus in the form of additional bank reserves. Actual rate hikes are still far down the road — “a considerable interval” after the Fed stops buying assets, he said.
Despite all of Bernanke’s efforts to explain the FOMC’s monetary strategy, financial markets worldwide tanked, perhaps not surprisingly. Stocks and bonds plunged and still haven’t recovered. But most Fed officials, while not wanting to see persistent adverse market moves of the kind that could undermine the very economic projections upon which tapering would be predicated, recognize that sometimes central bankers have to let the chips fall where they may if they’re going to honor their commitment to adjust policy to changing economic conditions.
The Fed could not simply keep creating new reserves at a $1 trillion pace indefinitely in the face of improving labor markets and mounting risks that super-low interest rates eventually might undermine financial stability.
The cost-benefit ratio has changed, and with it FOMC sentiment on monetary policy.
Since the meeting, better than expected June jobs figures — a 195,000 rise in payrolls, coupled with a 70,000 upward revision to prior months — tended to reinforce the case for some scaling back of bond buying in the next few months. More such data will be needed to cinch a September move.
Bernanke had an opportunity, as this was written, to recalibrate and refocus markets in a speech to a National Bureau of Economic Research conference, but in the final analysis he said nothing to disabuse realistic Fed watchers of their expectations that less generous doses of monetary stimulus are on the way.
True, the Fed chief said the decline in the unemployment rate to 7.6% from a peak around 10% overstates the labor market’s health and said a “highly accommodative policy is needed for the foreseeable future.” But he also voiced optimism. And after all, policy would still be “highly accommodative” if the funds rate remains near zero and the Fed were buying $65 billion of bonds per month instead of $85 billion.
Once “tapering” has begun, there is no guarantee that it’s going to proceed at a steady or mechanical pace. Depending on the employment and inflation data, among other factors, the FOMC could decide to make an initial reduction of, say $15-$20 billion, then hold at that new level of buying for some months before resuming the reductions — or even go back up if the data dictate.
Although the economy has shown more resiliency than many expected in the face of the ballyhooed “fiscal drag,” and although the FOMC’s “central tendency” forecast is for real GDP growth to reach 3%-3.5% next year, plenty of doubt remains about just how strong growth and job creation will be.
Bernanke and his colleagues have long said that monetary policy alone cannot do the job — that it needs help from other branches of government.
Higher taxes and fear of higher taxes borne of record deficit spending clearly have been a factor in slowing economic growth. But Fed officials aren’t just talking about fiscal policy.
They often have averred that “the large volume of new regulation,” as Richmond Fed President Jeffrey Lacker recently called it, is impeding business hiring and investment. Perhaps the Obama Administration was taking note of what Fed policymakers and others have been saying when it decided to delay implementation of the Affordable Care Act’s employer mandate.
But there’s plenty more of that sort of thing that, arguably, could cloud the economic outlook and keep the Fed from moving toward the exit as soon as it might like.
Steven K. Beckner is senior correspondent for Market News International. He is heard regularly on National Public Radio and is the author of “Back From The Brink: The Greenspan Years” (Wiley).