– Fed To Cut Treasury Securities By $10 Billion; MBS $5 Billion Per Month
– Powell: Tapering Apt to End Mid-2022, but Adjustable Depending on Conditions
– FOMC Still ‘Expects’ Inflation To Be ‘Transitory,’ but Powell More Worried
– Powell Says ‘Won’t Hesitate’ To Raise Rates to Counter Inflation if Needed
By Steven K. Beckner
(MaceNews) – After much anticipation and some dread, Federal Reserve policy-makers took a momentous first step Wednesday toward retracting some of the emergency monetary stimulus the Fed has been injecting into the financial system since last March to protect the economy from Covid-related shutdowns.
The Fed’s policy-making Federal Open Market Committee left the key federal funds rate, and in turn other short-term interest rates, in the zero to 25 basis point target range it’s been in for the last 20 months. However, it announced it will begin reducing the $120 billion per month asset purchases it’s been doing to hold down long-term rates “later this month.”
The FOMC said it will scale back purchases of Treasury securities by $10 billion and agency mortgage-backed securities by $5 billion per month, beginning in late November. Initially, purchases of Treasuries will be reduced to $70 billion and MBS to $35 billion. In December, purchases will decline to $60 billion and $30 billion respectively.
Elaborating on the FOMC statement in a press conference, Chairman Jerome Powell strove to strike a balance in how the Fed will pursue its potentially conflicting employment and inflation objectives.
Several times, Powell said the Fed can be “patient” in waiting to see how labor markets and inflation evolve as the economy gradually recovers from Covid-related supply disruptions through the first half of next year. So, he said there is no rush to raise interest rates.
At the same time, though, the Fed chief said several times the Fed “will not hesitate” to raise rates if inflation persists at levels inconsistent with the Fed’s average 2% goal. If necessary, he said the Fed could accelerate the pace of tapering to counter wage-price pressures.
While projecting $15 billion monthly reductions in bond buying, the FOMC statement allowed for a more flexible timetable, stressing “tapering” will be subject to change, depending on evolving economic and financial conditions.
“The Committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook,” the statement said.
Powell said $15 billion monthly reductions would put the Fed on course to “finish by the middle of next year,” but said, “we are prepared to deviate from that path if warranted by changes in the economic outlook .…”
“We are prepared to speed up or slow down the pace of reductions in asset purchases if it’s warranted by changes in the economic outlook,” he said, pledging, “If we feel something like that is happening, we will be very transparent.”
Powell added, “We wouldn’t want to surprise markets. We will say in light of these factors we are considering doing this and then we would either do it or not do it.”
Even after the Fed finishes tapering, its greatly enlarged bond portfolio will continue to provide accommodation, Powell said, although he said the FOMC has not begun to consider whether the Fed will prevent balance sheet shrinkage through reinvestments and rollovers.
Powell was careful to separate the decision to taper from the eventual decision to start raising the funds rate. He emphasized that ending asset purchases is not tied to rate hikes, although the FOMC has previously indicated it is a prerequisite for “liftoff” from the zero lower bound.
“Our decision today to begin our tapering or asset purchases does not imply any direct signal regarding our interest rate policy.”
“We continue to articulate a different and more stringent test for the economic conditions that would need to be met before raising the federal funds rate,” he added.
Although sufficient progress toward the FOMC’s employment and inflation goals has been made to start tapering, Powell said the economy has not yet reached “maximum employment.” Hence, “it’s premature to raise rates today.”
“I don’t think it’s controversial,” he continued. “I don’t see anyone arguing for that today.”
FOMC participants did not revise their funds rate projections at this meeting. At the Sept. 21-22 meeting, the 18 Fed governors and presidents were evenly divided between those who thought “liftoff” should begin before the end of next year and those who thought it should be delayed until 2023. A new “dot plot” will be compiled at the Dec. 14-15 meeting.
While calling liftoff “premature,” Powell vowed the Fed will raise rates as soon as it becomes necessary.
“The time for lifting rates will be dependent on the economy,” he told reporters. “If a response is called for, we will not hesitate. We are watching carefully to see if the economy evolves in line with our expectations and policy will adapt appropriately.”
Making the FOMC’s decision to reduce monetary support all the more significant was evidence the economy is cooling, which Powell acknowledged. For the time being, mounting inflation worries overrode any concern policy-makers may have had about GDP growth or employment.
Also meaningfully, the FOMC went ahead with reductions in asset purchases despite fears of repeating the 2013 “taper tantrum” and despite the spike in longer term bond yields that has occurred in recent months as it became clear Powell and Co. were moving toward tapering. The 10-year note yield, which sank below 1.13% in early August, climbed as high as 1.69% in late October, before retreating to 1.54% ahead of the FOMC announcement.
The FOMC did not dramatically change its characterization of inflation but did retreat somewhat from its former flat assertion that “inflation is elevated, largely reflecting transitory factors.”
Now, the latest statement says, “Inflation is elevated, largely reflecting factors that are expected to be transitory.” And it adds, “Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors.”
Explaining the change in wording, Powell said, “We took a step back. We said ‘expected’ to be transitory to show uncertainty around that …. We added some language to really explain more what we are talking about in paragraph two and paragraph three. We said supply and demand and balances related to the pandemic and reopening of the economy have contributed to sizable price increases.”
“We are trying to explain what we mean and also acknowledging more uncertainty about transitory,” he continued. “It’s become a word that has received a lot of attention which is distracting from our message which we want to be as clear as possible.”
Although Powell and the FOMC hung on to the term “transitory,” the former’s rhetoric on inflation in the latest press conference reflected significantly more concern than in his previous one, as he responded to questions about rising wages and prices.
So far, he said he sees no evidence of a wage-price spiral but said “we will be watching carefully.”
The FOMC needs to take a “risk management” approach, Powell said. “We have to be aware of the risks, particularly the risk of significantly higher inflation.”
“If we see shortages and bottlenecks persisting into next year, if we see higher inflation persisting, we have to be in position to address that risk should it become really a threat — should create a threat of more persistent, longer-term inflation.”
At another point, Powell said, “The level of inflation we have right now is not consistent with price stability.” And he said, “I want to ensure people we will use our tools as appropriate to get inflation under control.”
Elaborating on his “patient” attitude, Powell said, “It’s appropriate for us to see what the labor market and what the economy looked like when they heal further.” He expressed the hope that as the economy “heals,’ “it will evolve in a way that will mean low inflation.”
And so, he reiterated, “We don’t think it’s time to raise rates now.” But he added, “If we do conclude it’s necessary to do so, we will be patient, but we won’t hesitate.”
Powell, who’s appointment to a second term as chairman is in doubt, has come under increased criticism amid charges of conflict of interest among Fed policy-makers and the soaring cost of living. But he defended the central bank’s monetary policy.
“I don’t think we are behind the curve,” he said. “I believe policy is well-positioned to address the range of plausible outcomes.