MNI EXCLUSIVE: Fed Could Signal QE Debate By Summer -Ex-Offls

The Federal Reserve could signal that it intends to begin debating changes to its bond-buying program by summer time, although an announcement on tapering would not come until at least several months later, former Fed officials told MNI.

While Fed Chair Jay Powell has resisted talk about exiting from its accommodative stance, massive fiscal programs coupled with declining virus cases and an improved rollout of vaccines has boosted the outlook and pulled forward the timeline for winding down QE, the former officials said.

A message could be sent in the summer, possibly at the annual Jackson Hole conference in August, to "signal that discussions are starting" in the Fed system about how it would want to dial down its asset purchase program, said Steven Kamin, a former director of the division of international finance at the Fed Board.

Fed officials have maintained the need to keep bond purchases going until "substantial further progress" is seen in the labor market and on inflation and have said it could be "some time" before that progress is made. Powell has pointed to a deep job market hole of 10 million or more relative to pre-pandemic times, but others on the FOMC have indicated an interest in seeing the QE debate begin this year out of concerns that asset purchases create market imbalances.

Markets largely expect QE taper to begin in the first quarter of next year, and the Fed has signaled the tapering process could take nearly a year.

HOTTER LABOR MARKET

"Employment would need to be a few million higher than it is today," said Jonathan Wright, a former Fed Board economist. But with the Biden fiscal package and in an "optimistic" scenario, QE taper could be announced as early as the summer with the taper itself beginning by the end of the year, he said.

"The Committee won't announce tapering until we are just about there" on inflation and employment, added Wright, pointing to Fed desires to pull those who have given up job searches off the sidelines.

The Fed may be a little more conflicted as the year progresses, Kamin added. "On the one hand they want to signal confidence in the recovery, and on the second hand they would want to signal a debate on purchases to show they are not behind the curve as the recovery moves forward" and rates rise.

Others told MNI they expect Fed to continue purchasing at least USD120 billion a month into early 2022, as memories of the slow recovery after the financial crisis stay top of mind.

"I anticipate we will hear in the fall how the Committee is discussing how to slow asset purchases," said Vincent Reinhart, former director of the division of monetary affairs at the Fed Board. The Fed may be behind the curve and adjust a bit late, "leaning in one direction" toward dovish policy, he said.

Adding to the pressure is the fear of repeating the taper tantrum of 2013 and the recognition that markets and the Fed could see taper moves from different perspectives. "Markets often see tapering as tightening monetary policy, but for Fed economists it means adding stimulus less quickly," said Kamin.

SEPs TO GUIDE

The former officials interpreted the ongoing rise in Treasuries as a direct consequence of sharply higher near-term growth expectations. Current yields are in the ballpark of fair value and there is no reason to worry that it chokes off green shoots in the economy, they said.

With Biden's additional fiscal relief, the 10-year yield could be pushed up to 2% this year, which would be welcome, Wright said.

Still, the former officials said refocusing the Fed's bond buys on the long end of the curve, while unlikely in the near-term, is not off the table entirely as an option later if long-end yields surge and don't accurately reflect growth prospects.

The Fed's quarterly Summary of Economic Projections (SEP) will also guide markets, as MNI earlier reported, and March's projections will show in more detail how the central bank has seen Biden's USD1.9 trillion fiscal proposal.

"If you were looking for signs that the Committee was highly surprised by the Biden plan and how it would respond, the place to look down the line would be to look at the SEP's 2021 and 2022 GDP and inflation projections and whether liftoff in the Dot Plot has been moved," said Kamin, who is now at the think tank American Enterprise Institute.