MNI EXCLUSIVE: Fed Faces Pressure On QE Guidance- Ex-Officials

The Fed may need to offer more concrete direction on QE to calm markets underwhelmed by new interest-rate guidance, especially with an economy facing a second wave of Covid-19 and the unwillingness of Congress to extend fiscal aid, former top Fed officials tell MNI.

"I'm a little puzzled by the absence of movement on tying guidance to large scale asset purchases," David Wilcox, former research director at the Federal Reserve Board in Washington, told MNI.

"I can only infer that an effort was made but it wasn't possible to achieve consensus on it," he said. "I hope the committee will continue to work for greater clarity on that part." The FOMC's decision last week included two dissents even on the guidance that was given.

The Fed surprised Wall Street last week by promising to hold rates near zero until it achieves a modest overshoot of 2% inflation to make up for past shortfalls, in the first meeting since adopting a new long-run policy framework. Stocks fell after Wednesday's decision and again on Monday in part because investors saw the pledges as insufficient to correct the long undershoot of the inflation target or to sustain the economy through the pandemic.

The Fed's guidance represents some progress for the slow-turning institution, but perhaps not fast enough for markets or the broader public, former Fed Governor Randall Kroszner said in an interview. "They have a not so rosy economic outlook and they didn't give us much," he said.

STRONG AND POWERFUL?

While Chair Jerome Powell called the stance "strong and powerful," the public may also be right to ask how the plan will end up delivering, Kroszner said. "A perfectly reasonable question from real people would be -- that's fine you're talking about this but you haven't hit 2% in the last decade, so what's all this huffing and puffing about being moderately above 2% if you don't seem to have any idea as to how to get there?"

The prospect that politicians in Washington will fail to deliver fresh meaningful fiscal stimulus to families and businesses at least until early next year makes the achievement of the Fed's objectives even harder. The Fed is also unlikely to break tradition and roll out a big new policy at its next meeting around election time, so the economy could need even more of a jolt down the road.

Officials have discussed both potentially increasing the pace of bond buys if conditions worsen or, less ambitiously, extending the current average maturity of purchases, sources say. The Fed is currently buying USD80 billion in Treasuries per month and USD40 billion in mortgage-backed securities.

"The tool that everyone will look for them to employ is more asset purchases," Michael Feroli, chief U.S. economist at JP Morgan and a former staffer at the New York Fed, told MNI.

FEAR OF COMMITMENT

"I doubt the efficacy of that tool will be meaningful in the current environment. I believe there is a logical limit to the ability of central banks to stimulate growth and we are near that limit," Feroli said. The Fed's balance sheet now stands at almost USD7.1 trillion or 36% of GDP.

Thomas Hoenig, the ex-Kansas City Fed President, thinks the Fed may be loathe to commit on guidance around future asset buys, despite pressure to do so. Such actions depend on the path of the economy and, although the central bank would rather not admit it, the size of future budget deficits.

"There's a realization that bond buys are here to stay--they are absolutely bound to purchasing this debt," Hoenig said in an interview.

How much "is going to depend on the fiscal side on the economy more broadly and that's a ways down the line from their perspective," he said.

Wilcox, the former former chief Fed economist, says that while the power of bond purchases may have diminished, there is still more stimulus the central bank could provide.

There is a "a significant amount of remaining potential accommodation that could be achieved--at least a portion of that with a more aggressive side of forward guidance on purchases," he said.