Fed Nears Accord on How to Exit Record Stimulus With Timing Still Unclear
Federal Reserve policy makers neared agreement on the sequence of tools they will use to withdraw record monetary stimulus, with little accord on when to start.
The central bank should first end its policy of reinvesting proceeds from maturing securities and later raise interest rates and sell assets, majorities of policy makers said at their April 26-27 meeting, according to minutes released yesterday. The caveat: Talks about the exit strategy don’t mean that tightening “would necessarily begin soon,” the report said.
“It’s almost like planning for retirement but not knowing when you’re going to retire,” said Keith Hembre, a former Fed researcher who’s now chief economist and investment strategist in Minneapolis at Nuveen Asset Management, which oversees about $205 billion.
The discussion shows how Fed Chairman Ben S. Bernanke and his colleagues are trying to reassure investors that they can manage an unprecedented effort to unwind a $2.6 trillion securities portfolio and raise a near-zero benchmark interest rate. Getting the timing right may determine whether the Fed can contain inflation without unnecessarily harming economic growth and employment.
“There’s a fairly stark division” among Fed officials about when to exit, Hembre said. Still, he said there’s no hurry among the Fed’s top three officials -- Bernanke, Vice Chairman Janet Yellen and William C. Dudley, president of the Federal Reserve Bank of New York. Those three are “driving the boat here.”
The dollar pared losses against the euro, while U.S. stocks and 10-year Treasury yields extended gains after the release of the minutes. The Standard & Poor’s 500 Index climbed 0.9 percent to 1,340.68 at 4 p.m. in New York, and the 10-year yield rose to 3.18 percent from 3.12 percent.
The minutes reflected the first detailed discussion of the Fed’s exit strategy since the central bank started to buy $600 billion of Treasury securities in November. The purchases are the second round of so-called quantitative easing, following a $1.7 trillion program that ended in March 2010.
The timing of an exit got less discussion in April than in the March 15 meeting, when policy makers differed over whether to begin withdrawal this year. A “few” took the position on each side, minutes of that meeting said.
Last month, a “few” members saw the “increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant the Committee taking steps toward less-accommodative policy sooner than currently anticipated,” the report said.
Talks on the exit were deeper. Almost all officials agreed that the “first step toward normalization” should be ceasing reinvestment of principal payments on mortgage debt that began in August, the FOMC said. A majority preferred to sell the Fed’s securities after raising short-term interest rates, and most wanted to put asset sales on a preannounced schedule while using federal-funds rate increases as an “active tool.”
Policy makers agreed that the Fed’s securities portfolio, set to reach $2.6 trillion next month, would be shrunk “over the intermediate term” and return to “essentially only Treasury securities,” the minutes said.
The minutes were the first to be released since Bernanke, 57, held his first regular press conference after the FOMC meeting ended April 27. The Fed released the quarterly economic projections of its governors and regional bank presidents the same day. The forecasts were previously disclosed with a three- week delay in the minutes.
Officials were most divided in April over how and in what order to use asset sales and interest rates to tighten credit. Many of the policy makers who wanted to put sales on a preannounced path said the pace should be gradual and could still be adjusted based on the economic outlook, while several preferred to use the pace as a “key policy tool” that could be “varied actively.”
A few policy makers said asset sales should precede any interest-rate increase, and a few others indicated both moves should “commence at the same time,” the minutes said.
“They were just laying out the strategy but very clearly not moving toward implementation,” said Carl Riccadonna, senior U.S. economist at Deutsche Bank Securities Inc. in New York. “There is not a lot of conviction on the strength of the economy as well as the upturn in inflation” in the minutes.
St. Louis Fed President James Bullard said any tightening campaign should begin by shrinking the Fed’s balance sheet, which could be done “passively” by not reinvesting maturing mortgage-backed securities or by actual sales.
‘Controversial and Undecided’
“Whether you would supplement that with actual sales is controversial and undecided at this point,” Bullard said yesterday in an interview before release of the minutes. Interest-rate changes would represent “bringing out the big guns” and likely come later, he said. Bullard indicated he would favor shrinking assets “a fair amount” before raising rates.
When officials met in April, crude oil was trading close to its highest price since 2008. Inflation expectations, as measured by the breakeven rate for five-year Treasury Inflation Protected Securities, had climbed to 2.41 percentage points from 1.73 points at the end of 2010.
Bernanke took several questions about inflation at his press conference, saying that “ultimately, if inflation persists or if inflation expectations begin to move, then there’s no substitute for action.” He indicated that he wasn’t concerned yet because “medium-term inflation expectations” had “not really moved very much.”
Crude Oil Drops
Since that briefing, crude oil has dropped to $99.65 a barrel from $112.76, while the five-year TIPS breakeven rate has declined to 2.18 percentage points.
The decline may help validate the FOMC’s judgment in the April statement that higher inflation from a rise in commodity prices earlier this year will be “transitory.” The Fed’s preferred price index, which excludes food and fuel costs, rose 0.9 percent in March from a year earlier, close to a five-decade low of 0.7 percent in December.
U.S. central bankers aim for an inflation rate of about 1.7 percent to 2 percent, based on last month’s long-run economic projections of Fed policy makers.
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