By Steven K. Beckner
(MaceNews) – Having started “talking about talking about” scaling back asset purchases at their mid-June Federal Open Market Committee meeting, Federal Reserve policymakers will presumably begin really “talking about” “tapering at the July 27-28 FOMC meeting.
The timing of actual reductions in bond buying, however, remains very much in doubt, although there has been lots of speculation, heavily influenced by whatever the speculators’ economic forecasts happen to be.
The Fed’s own forecasts are interesting, but only take us so far, because not even the Fed really relies on them anymore.
Let’s also remember that the first, moderate increments of tapering will come only at a lag after the FOMC has concluded that “substantial further progress” has, in fact, been made toward its maximum employment and average 2% inflation objectives. The delay will depend on the Fed’s best guess as to how much advance notice it needs to give to avoid a 2013-style “taper tantrum.”
So, yes, everyone would like to know when the Fed is going to taper. And the answer is easy – provided you know what the economy is going to do the rest of the year.
The problem, of course, is no one does – not even the Fed. In fact, as Fed officials will freely tell you, their forecasting record isn’t any better than anyone else’s.
Notwithstanding its dismal record, the Fed used to be an avowedly forecast-oriented central bank. It is now, as New York Federal Reserve Bank President John Williams reminded us recently, “outcome based.” In other words, more than ever, monetary policy is going to be guided by a multitude of data. And right now, the data is very hard to read.
Fed officials regularly remind us that there is “an unusual amount of uncertainty” – an assertion that rings truer in these post-Covid days when a reopening economy confronts unfamiliar cross currents of resurgent demand, supply bottlenecks, labor market disruptions and alarming price pressures.
So trying to figure out when tapering will come is educated guess work. The best we can do is try to interpret what Fed policymakers are saying.
We do have the minutes of the June 15-16 meeting to ponder, which confirm what we already knew from Powell’s post-FOMC press conference – that the Committee had begun a discussion of tapering. Beyond that, care needs to be taken in reading them.
Much was made of a passage which disclosed that “various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of incoming data.”
Now, “various” usually means more than “a few” or even “several,” but note the minutes did not say “most” or even “many” participants as they surely would have done if a majority or plurality of FOMC participants had thought it would be appropriate to start tapering “somewhat earlier than they had anticipated.”
Then too, “somewhat earlier” is hard to infer, but for some officials it could mean early next year rather than spring or mid-2022.
Further muddying the waters, the minutes revealed that “some participants saw the incoming data as providing a less clear signal about the underlying economic momentum and judged that the Committee would have information in coming months to make a better assessment of the path of the labor market and inflation.
As a result, several of these participants emphasized that the Committee should be patient in assessing progress toward its goals and in announcing changes to its plans for asset purchases.”
“Participants generally judged that, as a matter of prudent planning, it was important to be well positioned to reduce the pace of asset purchases, if appropriate, in response to unexpected economic developments, including faster-than-anticipated progress toward the Committee’s goals or the emergence of risks that could impede the attainment of the Committee’s goal,” the minutes added.
A number of Fed officials have pointed toward September as the earliest time to have enough data to judge “substantial further progress.” Some, such as voting Chicago Fed President Charles Evans, have looked beyond that data. At whatever point critical mass is reached for an FOMC consensus, we have to factor in a fairly long lead time for actual tapering if Powell and company are going to be true to their pledge to be “transparent” and communicate “well in advance of actually tapering.”
The picture hasn’t gotten a lot clearer since Powell talked to the media on June 16. In two days of testimony on the Fed’s semi-annual Monetary Policy Report to Congress July 14 and 15, Powell reaffirmed that the FOMC would have another round of discussions on this very topic” at the upcoming meeting.
But the Fed chief betrayed no sense of urgency about reducing the $120 billion of monthly bond purchases the FOMC reauthorized on June 16.
For one thing, he said the Fed still has “a long way to go” to meet its “maximum employment” objective and repeatedly downplayed inflation risks after the Labor Department reported that the Consumer Price Index had risen 5.4% year-over-year in June. True, Powell said the Fed wouldn’t hesitate to react if inflation were to persist in a “troubling” way, but he continued the “transitory” mantra.
Powell was measured, if not bland, in talking about tapering in his prepared testimony: “While reaching the standard of ‘substantial further progress’ is still a ways off, participants expect that progress will continue. We will continue these discussions in coming meetings.”
He reiterated a pledge to “provide advance notice before announcing any decision to make changes to our purchases.”
Legislators were unable to pin Powell down any more precisely about just what “substantial further progress” means in the give-and-take following the prepared testimony.
“We didn’t try to write down a particular set of numbers that would capture that (substantial further progress),” he said. “It would have been complicated and not particularly worthwhile. So we said ‘substantial further progress,’ which is similar to what we did during the recovery from the global financial crisis years ago. We had a similar kind of set of words for when we would taper asset purchases.”
“The thing is it’s very difficult to be precise about it, because with maximum employment there are no three or four or five or six metrics that you could point to,” he continued. “It really is a very broad range of things, including wages, unemployment, levels of employment, participation, all those things. So we just said ‘substantial further progress’”
“And we also said that we would provide advance notice … well in advance of actually tapering, understanding that this is somewhat of a discretionary test, and that we don’t want to surprise markets or the public,” Powell went on. “So we will provide lots of notice as we go forward on that.”
Powell told the House Financial Services Committee, “If we continue to make progress toward our goals you will see us beginning to reduce those purchases.”
Earlier that week, Williams was equally vague about when he thinks sufficient evidence of progress will have been accumulated to start scaling back asset purchases.
But like Powell, the FOMC vice chairman seemed to be in no hurry, making clear he wants to see a lot more data on both employment and inflation before concluding that the goal of “substantial further progress” has been achieved.
“I’m watching the data carefully across a wide variety of indicators,” he said, adding the FOMC has “set a very clear marker … . We want substantial further progress relative to the end of last year. That’s where I’m focused.”
With the economy experiencing both demand and supply shocks related to the pandemic, Williams said, “It’s really important for us to think about” the data in deciding “what’s the appropriate timing for reducing purchases of assets.”
“In the last few months, we’ve seen some strong movements and cross currents in both the employment and inflation data,” he said. “I want to see more data” in order to “draw stronger conclusions about inflation and employment … . So we’ll just have to see on that.”
“This is a time of very high uncertainty,” Williams averred. Hence, “We need to watch the data carefully and analyze it and make an appropriate decision when we have the information to make those decisions.”
Pressed in a webinar to give a timetable for a tapering decision, Williams retorted, “I’m not going to give a forecast on when the committee the FOMC gave itself “the flexibility to adjust as appropriate” by using “outcome-based guidance … . It’s really about achieving our maximum employment and inflation goals – ‘substantial further progress’ based on what the data are telling us … . The timing will follow from that.”
Evans sounded, if anything, more hesitant to conclude that the economy is on the cusp of “substantial further progress” as he pointed toward “fall” for making such a determination.
“It’s going to take a few months, probably more than just a few months (to make a judgment on ‘substantial further progress’),” he told me and some colleagues a day after Powell’s first day of congressional testimony. “I kind of think that by the fall we’re going to be able to see this better.”
By then, “We’ll be making some judgments,” he said. “I mean, I’m looking for substantial further progress.”
Evans, who is projecting 7% real GDP growth and 4 ½% unemployment at year’s end, told us, “I have to say that if unemployment comes in securely at 4.5% at the end of this year, if the way those gains are distributed is in line with reasonably vibrant labor market where large numbers of people are sharing in that, that would be excellent progress.”
“I think if inflation looks like it’s not off the tracks in terms of being well above transitory, temporary inflation that I’m seeing right now, then I can easily imagine a discussion about our tapering, where a judgment is made that, yes, that does seem like substantial further progress,” he continued.
“I don’t have a month in mind, but I can see the trajectory of that,” he added.
Evans said that the very fact that Covid has blurred the inflation picture “is why I think we could require a little time than many people would prefer” to come to decide to taper.
“Certainly, I’d like to have the answer today, but that is just part of what we need to do,” he went on. “I am comfortable with where we’re going and I don’t see markets as being uncomfortable, especially given the yield curve and how that’s playing out. So I think we’re on a good trajectory.”
Labor market uncertainties add to uncertainties about inflation to complicate FOMC decision making, in Evans view. “I think with the labor force, with child care, with a number of these other types of issues, there is more uncertainty, and it does make me wonder.”
“I do think that unemployment is going to be under 5% at the end of this year. I think it’s going to be 4.5%,” he continued. “But I think a number of things have to break carefully, and given the more recent months of lower employment growth than I was expecting, there are still things to assess in terms of ‘substantial further progress’ that needs to be met for us to make adjustments in our monetary policy stance.”
Evans said “we’re going to have to be looking at the employment improvements. I think we were disappointed a few months ago, but I think it’s started to turn up.”
The labor force participation rate “is going to be very important,” he added.
Like Powell and Williams, Evans refused to give a timetable for tapering, reiterating, “We’re just going to have to be monitoring the data.” But he seemed to point toward later 2021 at the earliest, although he was vague about whether that would be the time for making a tapering announcement or actually tapering.
Evans outlined his personal parameters: “I want to know we’re on track for unemployment (to fall to his projected 4.5%) nationally by the end of this year. So I’m looking to see that we’re on track. We’re at 5.9%, so I would expect it to start moving down more substantially and not go sideways, because sideways is sort of a challenge.”
At the same time, “We’ve got to look at inflation,” he said. “I have an amount of confidence that the high numbers we’re seeing right now will be transitory one-offs, and I think that as we go into 2022, we’ll see a more normal inflation environment.”
“But I could be wrong, and as we monitor that if inflation looks to be more persistent, looks to be more inconsistent with our objectives, then we have to stop and think that maybe we need to modify our stance, perhaps a little earlier than I think,” he went on.
“But if unemployment is at 4.5% at the end of the year and things are progressing the way that I’m expecting, I would guess that some adjustment would be in order somewhere in that (late 2021) time frame probably, but it’s going to depend on the data,” he added.
Evans allowed for the possibility that a tapering decision “could come more quickly if we see substantial progress very quickly. if the pace picks up.”
“I do think this is going to be one of those things where we’re going to have to have an accumulation of more months,” he elaborated. “I think if the employment situation had not had that sort of little flattening before, we could have been on track a little bit earlier … . I think it’s going to take more than a couple of months to sort this one out.
Evans concluded that, “It’s probably going to take into the fall” before the FOMC can reach a tapering decision.
Of course, such comments beg the question of how long after “substantial further progress” has been assessed the Fed will make its first cutbacks in bond buying. But one has to think there will be a fairly long lead time, given the much-advertised commitment to signal tapering “well in advance” and given the still-regretted 2013 experience, when bond markets went nuts even though former Fed Chairman Ben Bernanke had adequately signaled the coming of tapering.
There is nearly as much interest in the what the FOMC will ultimately decide about the composition of asset purchases as there is about when overall asset purchases will be cut. Currently, as reaffirmed on June 16, the Fed is buying $80 billion of Treasuries and $40 billion of agency mortgage backed securities per month.
At the June 15-16 FOMC meeting, the minutes tell us, “Several participants saw benefits to reducing the pace of these purchases more quickly or earlier than Treasury purchases in light of valuation pressures in housing markets.” However, they added, “Several other participants, however, commented that reducing the pace of Treasury and MBS purchases commensurately was preferable because this approach would be well aligned with the Committee’s previous communications or because purchases of Treasury securities and MBS both provide accommodation through their influence on broader financial conditions.”
This is not a settled issue, but as of now, the Fed leadership and other voting members do not seem strongly inclined to disproportionately reduce MBS purchases relative to Treasury purchases.
Certainly Powell gave no such indication in response to numerous congressional suggestions that the strong housing market warranted slashing MBS purchases. He said it is the combination of MBS and Treasury purchases, not to mention keeping the federal funds rate at the zero lower bound, “all go into producing a low interest rate environment and go into mortgage rates,” he said.
“Mortgage-backed security purchases really work a lot like Treasury purchases,” Powell said. “They aren’t especially important in what’s happening with housing prices.”
Powell acknowledged that MBS purchases are “clearly a factor among factors” supporting housing. “So this is one of the things we’ll be considering as we go through this process of evaluating when to taper and in what form – what will be the composition of asset purchases going forward. Those are all issues that we will be discussing at this next meeting in a couple of weeks.”
But the Fed chief said MBS purchases are “not intended to provide support for any industry, including the housing industry.” MBS purchases “do support low mortgage rates .., but it’s not that we’re looking at the housing market. We want to support overall demand.”
“Really we look at the whole things we’re buying – Treasury and MBS,” Powell went on. “Both have the same kind of effects on the economy. MBS has more effect on housing; that’s not the reason we were buying them in the first place. We’re in the process of looking at tapering those purchases.”
Williams, not for the first time, also suggested both types of securities purchases are needed going forward. He said “the lesson of the past decade is that asset purchases on both MBS and long-term Treasuries do provide monetary accommodation to support economic growth and (meet) our employment and inflation objectives.” But he went on to suggest he favors continuing MBS and Treasury purchases in tandem at the current proportions (one-third of the former, two thirds of the later.
Williams conceded MBS purchases “do have some extra effect on mortgages,” but said it is “overall purchases of both of these that are really providing accommodation … . They’re providing monetary accommodation in tandem for … providing support for economic recovery.”
Evans said he “doesn’t really have strong views,” but favorably cited the observations of Williams, whose Bank’s open market trading desk runs the asset purchase program.
Williams “made a very good point and others that all of these asset purchases are serving a purpose for providing accommodation,” he said. ““It’s not narrowly directed. Although it is MBS and it seems like it is narrowly focused toward housing, it has much larger effects throughout markets and the way markets are functioning.
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Contact this reporter: steve@macenews.com.
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