The end of easy money
The Federal Reserve Board is considering pulling back on its bond purchases, but it won’t be easy to wean the market from the stimulus it now considers nearly essential.
The release of the minutes from the October meeting sparked a round of media coverage. The Wall Street Journal wrote this story:
Federal Reserve officials, mindful of a still-fragile economy, are laboring to devise a strategy to avoid another round of market turmoil when they pull back on one of their signature easy-money programs in the months ahead.
Central-bank officials have been debating for months when to start paring the $85 billion-a-month bond-purchase program. They were surprised during the summer when their discussions and public pronouncements on the potential timing rocked markets, pushing interest rates higher and stock prices down.
Minutes of the Oct. 29-30 policy meeting, released Wednesday, showed officials continued to look toward ending the bond-buying program “in coming months.” But they spent hours game-planning how to handle unexpected developments and tailoring a message to the public to soften the impact of the program’s end.
Investors responded Wednesday with new disappointment. The Dow Jones Industrial Average fell 66.21 points, or 0.4%, to 15900.82. The Dow had crossed the 16000 mark during intraday trading for the second time this week, but turned negative following the release of minutes from the Fed’s Oct. 29-30 policy meeting. Bond yields rose to a two-month high, with the 10-year Treasury notes climbing 0.083 percentage point to 2.795%.
The Fed’s next policy meeting is Dec. 17-18. The decision on whether to act then on cutting back on bond purchases will depend largely on the strength or weakness of economic data over the next few weeks.
The New York Times pointed out the move has been in the works for some time, but the Fed is considering making it policies and factors for making a decision better known:
The outlines of that shift have been clear for some time. The Fed intends to reduce and then suspend its monthly purchases of Treasury and mortgage-backed securities. At the same time, the Fed is seeking ways of emphasizing that it remains determined to keep borrowing costs for businesses and consumers as low as possible well into the future.
The leading candidate, according to the account, is a proposal to include in the Fed’s policy statement, released after each meeting, a formal declaration that the Fed is likely to keep short-term rates relatively low even after it eventually decides to end the long period, dating back to 2008, that it has held those rates near zero.
The Federal Open Market Committee also discussed the possibility of describing some of the factors that it would consider in deciding how quickly to raise rates. So far, the committee has said only that it will keep interest rates near zero at least as long as the unemployment rate remains above 6.5 percent.
The Fed’s chairman, Ben S. Bernanke, employed both approaches in a speech Tuesday night, stating that the 6.5 percent threshold would be the point at which Fed officials would begin to discuss the timing of an initial rate increase. That suggests that when the official unemployment rate, currently at 7.3 percent, reaches that point, it will probably not initiate an immediate increase in the lending tool, known as the federal funds rate, that the Fed directly controls.
MarketWatch’s story said the Fed wanted to broadcast its position on rates and give unemployment guidance in an attempt to prepare investors for tapering of quantitative easing:
The Fed also was eager to clarify or strengthen the forward guidance for rates. “Several” said extra qualitative information could be provided after the 6.5% unemployment rate threshold was actually reached, which by the Fed’s own projections could come next year.
A “couple” wanted to reduce the 6.5% unemployment rate threshold, and a “few” wanted to add that the federal funds rate wouldn’t be raised as long as inflation was projected to run below a given level.
Also on the chalkboard: reducing the interest rate paid on excess reserves, setting up a standing purchase facility for shorter-term Treasury securities or providing term funding through repurchase agreements.
The Bloomberg story added economic context around the state of unemployment and what the Fed might need to see in order to pull back on bond purchases:
The FOMC has pledged to press on with so-called quantitative easing until seeing substantial improvement in the outlook for labor market. Employers added 204,000 workers to payrolls in October, more than forecast by economists, and the unemployment rate has fallen to 7.3 percent from the 8.1 percent rate the month before the central bank began a third round of bond buying in September 2012.
Participants said they still expect a pick-up in the pace of economic activity even as reports suggest growth in the second half of this year may prove to be “somewhat weaker than many of them had previously anticipated,” the minutes said. While they saw less risk for the economy, they also said “several significant risks remained,” specifically citing fiscal drag and budget standoffs.
Fed officials saw the economic impact of the government shutdown “as temporary and limited,” while a number said they were concerned about effects of “repeated fiscal impasses” on business and consumer confidence, according to the minutes.
All of the stories are helping the Fed make its policy well known before it actually makes a move. Having a window into their thoughts should be some comfort to investors. But if they actually believe the guidance remains to be seen.