Some thoughts on the Fed’s QE stance
A week ago I wrote that I believed QE will end this year after tapering off in June. I stand by this stance. However, we have heard from three Fed officials in the interim and I wanted to pass on what they are saying to gauge how likely it is that the Fed will taper QE in June and end it in 2014.
The Wall Street Journal’s blog Real Time Economics picked up on all three. First, there’s Charles Plosser of Philadelphia. Note that while what he says influences policy, Plosser is an alternate member of the FOMC and cannot vote on decisions.
The leader of the Philadelphia Fed said Tuesday any central bank exit strategy should return the institution to its pre-crisis roots, and he warned his colleagues not to over-rely on a relatively new power that allows them to pay interest on bank reserves.
The official, Charles Plosser, has been a consistent critic of the Federal Reserve‘s move to provide stimulus to the economy. He has opposed the central bank’s decision to push forward with an open ended campaign of Treasury and mortgage bond buying, amid worries about rising reserve levels and an ever growing central bank balance sheet that will at some point need to be shrunk.
Mr. Plosser believes now is a good time for the Fed to revisit its exit strategy, given that it’s been nearly two years since it’s been given formal consideration. While much of what he believed then still holds now, the official notes much has happened since then, most notably a massive expansion in an already historical swollen Fed balance sheet. For that reason, it would be good for the central bank to clarify the manner in which it will ultimately withdraw the stimulus it is still pumping into the economy.
“We should return to an operating framework in which the federal funds rate is our policy instrument, we should shrink the size of our balance sheet consistent with this framework, and we should shorten the duration and return the composition of our portfolio to all Treasuries,” Mr. Plosser said in the text of a speech prepared for delivery in Beijing.
So, consider Plosser in favour of tapering and then reversing the stimulus in a deliberate and considered way. The Wall Street Journal also notes at the very end of the piece that Plosser was against QE3 right from the start. And so his view against QE is not unexpected.
Then There’s Charles Evans of Chicago. He is a voting member of the FOMC. What is he saying? Here’s Real Time Economics again:
A key Federal Reserve official said Tuesday he expected its asset purchases to continue through the fall before winding down in 2014.
Charles Evans, president of the Federal Reserve Bank of Chicago, said the central bank’s monetary policy remains “appropriate,” though it may have to tinker with the plan laid out in June 2011 to start unwinding its balance sheet.
Mr. Evans told reporters after a speech in Chicago that he expected “with a high probability” that bond buying would continue into the fall. He added he “would not be surprised” if a wind-down carried over into 2014, though offered an upbeat assessment of the economy’s current trajectory and saw no immediate inflation threat.
Count Evans as being in favour of more QE then. The question I have is whether winding down QE in 2014 means tapering it, as in continuing QE into 2014 and only then tapering off purchases. Alternatively, Evans could actually be talking, like Plosser, of unwinding QE, reversing the stimulus by selling bonds into the market. It sounds like he expects tapering to start sometime mid-year and to continue into 2014. So that’s slightly more aggressive on QE than I was saying last week.
Finally, we have Bill Dudley. He is Vice Chairman and a voting member of the FOMC. So what he says carries significant weight. Here’s what he believes:
“The labor-market outlook has yet to show substantial improvement,” Federal Reserve Bank of New York President William Dudley said. “Consequently, I see the current pace of asset purchases as appropriate.”
But at some point, the official warned, “I expect that I will see sufficient evidence of improved economic momentum to lead me to favor gradually dialing back the pace of asset purchases.” He also said, though, that “any subsequent bad news could lead me to favor dialing them back up again.”
Mr. Dudley suggested no urgency to pull back on stimulus, saying “there is considerable uncertainty about the [economic] outlook.” He also said the benefits of the Fed’s bond-buying actions continue to exceed the costs of the program.
I would put Dudley into the dovish camp then. He too talks of paring back QE despite the problems in the real economy. But on the whole, it sounds like he is in favour of continued QE and does not want to commit to a timetable for tapering for fear that the real economy could worsen as that timetable is implemented.
Overall then, I would say these comments favour continued QE with a view to tapering, somewhat dependent on the economic data over the next few months. My assumption here is that what is unspoken is that part of the desire to taper purchases has to do with concern over frothiness in risk assets like high yield bonds. None of these three seemed to suggest this directly, however. I expect that good data lead to early tapering i.e. June. And then we would be done by the end of the year. Bad data lead to the timetable being pushed back – perhaps indefinitely, depending on the data flow.
From a market perspective, I would view these comments as neutral. They will have no material impact on markets as the views expressed do not signal a shift in policy.
P.S. – I also forgot to add a link to a Bloomberg post on Esther George of the KC Fed’s views. SHe is hawkish and concerned about stimulus creating bubbles that reduce long-term growth. But her views are known. Despite her being a voting member of the FOMC, I think this doesn’t change the overall consensus, which favours QE although they are looking to taper it.
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