MNI EXCLUSIVE: Fed To Keep QE Pace Despite Bigger Fiscal Boost

The Federal Reserve will keep up its monthly USD120 bond buying for the foreseeable future despite a much-larger-than-expected fiscal stimulus plan from the Biden administration and muddled public messaging from top policy makers which has helped push up Treasury yields, current and former central bank officials told MNI.

The Fed would have to see a significant shift in the economy's trajectory -- well beyond an expected springtime inflation spike related to year-on-year comparisons --for any tapering of QE to begin later this year or even early in 2022, they said in interviews.

That's especially true, the sources said, given the central bank's recent framework shift, under which it committed to make up for periods during which it undershoots its 2% inflation target.

Fed officials have offered mixed public messages about the timing of a potential decrease in the pace of asset purchases, but as MNI reported last week the Fed is not inclined to offer more specific guidance on the trajectory of its asset-buying.

Instead, sources say, officials are leaning toward the view expressed by Fed Chair Jerome Powell and other board governors that it's too soon to discuss the timing for unwinding QE.

"This is a good test for their new framework. Prior, you would have expected some pre-emptive tightening, as the forecast for unemployment and GDP moved upwards," said Jeremy Stein, former Fed board governor and chair of Harvard's economics department.

"But now, if you take them at their word, it is less obvious—they are basically saying they don't believe in the Phillips curve, and will wait to actually see the realized inflation before adjusting policy," Stein said.

This is not to say that the process will always be smooth, however, as recent market confusion regarding the Fed's messaging suggests.

FISCAL BAZOOKA

The transition in the outlook for fiscal policy has been drastic. As late as early December, it appeared Congress might not deliver additional support after the initial USD2 trillion relief package back in March.

Now, not only have lawmakers approved a USD900 billion package, but Joe Biden's arrival in office and the Democrats' slim control of both chambers of Congress has shifted the political debate toward the new president's USD1.9 trillion proposal.

Adding further uncertainty to the outlook is the upside risk that the coronavirus vaccine could lead to a strong rebound in economic activity during the latter half of the year, officials say.

As both the rollout of the vaccine and the Biden administration's fiscal policies take more concrete shape, Fed communications will become touchier for a Treasury market where 10-year yields have already comfortably surpassed the 1% mark and talk of repeating 2013's taper tantrum heats up. Treasury curves now suggest market participants do not rule out tapering as soon as the end of this year.

"That's why the Fed will have to communicate more forcefully," said Eric Winograd, a former analyst at the New York Fed and now senior economist at AllianceBernstein.

Additionally, as spring nears, low year-ago inflation figures will begin to drop out of the 12-month calculations, resulting in a potential "inflation scare" that could further complicate Fed communications.

"It's easy to push back right now and say growth is pretty weak and the economy isn't in great shape and inflation is still below our target. So, talk to me in four months when the economy is accelerating, fiscal policy is healthy, and inflation is rising," Winograd said. "It is going to be a communication challenge for sure."

All eyes will be on how Fed officials talk about the economy and the outlook for policy, as springtime--and hopefully more widespread vaccinations--take hold. But, as things stand, the central bank is on course to continue asset purchases at its current pace.