MNI EXCLUSIVE: Fed Prepared to Stick With Vague QE Guidance

The Federal Reserve's vague guidance on tapering asset purchases risks creating unwanted spikes in borrowing costs, but policy makers may be too far apart to refine it further, former officials told MNI.

Investors are calling for more specificity about what policymakers mean by "substantial further progress" in the economy, their criteria for gauging an eventual reduction of the Fed's USD120 billion a month of bond buys. Officials have further muddied the waters in recent weeks by taking divergent views on the timing of such progress.

Some regional Fed bank presidents have talked about tapering by early next year while Fed governors are pushing back on any perceived certainty on timing. President-elect Joe Biden's push for major new fiscal relief through a Senate that will still have 50 Republican votes further raises the specter of market confusion, and thus requires monetary officials to lay down more concrete markers.

"It is important that the Fed clarify their balance-sheet and interest-rate reaction functions," said Stephen Cecchetti, a former New York Fed executive vice president and research director now at Brandeis International Business School. "People need to understand what the triggers will be for policy to change."

FISCAL CURVE BALL

When the Fed delivered its December QE guidance, the chances of more fiscal relief still looked slim. Fed officials spent much of last year pleading with Congress to do more to support the economy, arguing monetary policy could not carry the rebound from a pandemic.

Since then, not only has Congress approved a USD900 billion package, but President-elect Joe Biden on Thursday night proposed USD1.9 trillion of additional relief.

The Fed is watching cautiously as 10-year yields keep rising above 1% to see whether the increase reflects optimism about growth -- or worries about premature central bank tightening in the face of rising bond issuance.

The Fed's December guidance was probably necessarily vague because of the internal disagreement on the likely path of monetary policy, sources said.

"They can't signal in advance with great precision what will be the criteria for making a change," Dennis Lockhart, ex-president of the Atlanta Fed, told MNI. "To me it's just in the nature of things that a certain degree of vagueness has to accompany the communication."

HIGH EMPLOYMENT BAR

Fed guidance on interest-rate hikes is more specific than for QE, aimed at affirming the commitment to making up for below-target inflation that prevailed during the last recovery and ensuring full employment.

"It's a pretty high bar in terms of substantial improvement in the employment picture, which suggests to me they'll be very patient about the stance of policy," Lockhart said. The Fed's own forecasts see the jobless rate falling from the current 6.7% down to 5% this year.

Fed Chair Jerome Powell said Thursday policy makers are going to be careful about communicating to markets "well in advance" before starting to reduce the pace of its bond buys.

"We know we need to be very careful about communicating about asset purchases," Powell said, adding that the "taper tantrum" experience of 2013 showed a "real sensitivity" for markets.

EMPHASIZING THE DISTANCE

Powell's comments show the Fed "is already being tested and the leadership has already tried to respond by emphasizing distance to goals," said Krishna Guha, a former executive vice president at the New York Fed.

Guha pointed to similarly dovish comments from Vice Chair Richard Clarida and Fed Governor Lael Brainard, which highlighted the divide with regional Fed hawkishness

"Expect more of the same if the market presses further," Guha said.