Fed Debated QE End in 2013 Amid Concern Over Total Assets
Federal Reserve officials, expressing concern over their swelling balance sheet, began debating an end to their unprecedented bond-buying as early as this year even while preparing to boost stimulus to a new record.
“Several” members of the Federal Open Market Committee said it would “probably be appropriate to slow or stop purchases well before the end of 2013,” according to minutes of their Dec. 11-12 meeting released yesterday. A “few” others were willing to let the program run to the end of the year while “a few others” didn’t give a time frame.
Chairman Ben S. Bernanke is exploring the timing for concluding his four-year campaign to cut borrowing costs and combat unemployment through unorthodox monetary easing. The FOMC minutes reveal concern over the challenge of shrinking a balance sheet that may grow to more than $4 trillion while potentially distorting financial markets and providing less kick to growth.
“It does sound like they are having a little bit of a gut check,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York. “Maybe they stared into the abyss and didn’t like the prospect of a $5 to $6 trillion balance sheet.”
The mention of a calendar-date end to accommodation surprised investors after Bernanke at a Dec. 12 press conference said the Fed will continue its $85 billion a month bond-buying program until officials see “substantial improvement in the outlook for the labor market.” The unemployment rate stood at 7.7 percent in November.
Stocks and Treasuries fell, pushing yields on the 10-year government note to a more than seven month high. The Standard and Poor’s 500 Index closed down 0.2 percent to 1,459.37, while the yield on the 10-year note rose 0.07 percentage point to 1.91 percent.
Bernanke told reporters Dec. 12 that the FOMC is “prepared to vary” its monthly purchases based on “new information.” Still, he made improvement in the labor market the primary hurdle for paring back the purchases, without pegging them to a fixed duration or total amount.
The “substantial improvement” approach is intentionally “qualitative,” Bernanke said, in contrast with the policy threshold created by the FOMC for a change to the main interest rate. The committee plans to keep the benchmark rate near zero until unemployment falls below 6.5 percent and as long as inflation remains below 2.5 percent.
Bernanke mentioned at the press conference two other potential triggers to an end to bond buying: If purchases lose potency for stimulus or increase financial market risk.
With purchases at a rate of $85 billion a month, the Fed’s balance sheet would grow by $1.02 trillion this year from $2.92 trillion now.
“There are clearly some growing pains in moving from policies that were very contained and closed-ended to ones that are more flexible,” said Julia Coronado, chief economist at BNP Paribas in New York. “They want to be very careful here.”
Several policy makers still want to center policy this year on a forecast for the labor market and the broader economy, according to the minutes. That suggests bond buying could continue beyond 2013 because Fed officials have routinely revised down their outlook as post-crisis economic growth proved surprisingly weak.
A year ago, Fed officials forecast growth this year of 2.8 percent to 3.2 percent, according to their central tendency estimate. By last month, their estimate dropped to 2.3 percent to 3 percent, a range that exceeded estimates by professional forecasters tracked by Blue Chip Economic Indicators, who forecast growth of 2.2 percent.
“These guys are overly optimistic all the time,” said Bret Barker, a portfolio manager at TCW Group Inc. in Los Angeles, which oversees $135 billion. “The only way they stop now is if we recovered or if they decide this isn’t working anymore.”
Fed officials last month also forecast little improvement in the labor market, with the unemployment rate averaging 7.4 percent to 7.7 percent in the fourth quarter of this year, according to their central tendency estimate. That doesn’t appear to meet Bernanke’s goal of “substantial improvement.”
Coronado of BNP Paribas and Feroli of JPMorgan Chase expect that the FOMC will purchase bonds into 2014. With continued caution by households and businesses and disagreement in Congress over fiscal policy, the U.S. economy “probably isn’t going to be performing at a level that is satisfying for monetary policy makers” by the end of 2013, Coronado said.
The post-crisis Fed has already postponed a planned end to stimulus, Feroli said. “We have seen an end date before” only to have it followed by more bond buying.
Prior to the Fed’s December meeting, in which it announced the addition of Treasury purchases to accompany mortgage-bond buying, the median estimate of economists in a Bloomberg Survey called for purchases to continue through the first quarter of 2014. Forty-six percent of economists in that survey saw the purchases ending in 2014.
The Fed may decide to shrink the pace of purchases around mid-year and continue at a slower rate into 2014, said Dana Saporta, an economist at Credit Suisse in New York.
Fed officials last month saw signs of improving fundamentals in the economy. “Many” officials said household balance sheets were improving as debt levels fell and home prices recovered while “net worth was approaching levels seen before the financial crisis,” the minutes said.
Economic reports released yesterday before the minutes suggest Fed easing is bolstering the world’s largest economy. ADP Research Institute data showed a 215,000 increase in employment last month, the largest since February, while the Bloomberg Consumer Comfort Index rose to minus 31.8 in the period ended Dec. 30, its highest since April, from minus 32.1 a week earlier.
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