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Policymakers need consensus on whether to zero out MBS or taper faster than 12 months, former Fed officials tell MNI.
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The Federal Reserve is probably looking at winding down its USD120 billion a month bond purchase program over 12 months, but could take a flexible approach as conditions change, with some officials lobbying for a faster reduction of mortgage bonds and some for a more rapid taper overall, former top policymakers told MNI.
A reduction of USD10 billion in Treasury purchases and USD5 billion in MBS per Fed meeting would be a "reasonable template" that would end purchases after eight meetings, or a year, in a similar fashion to that in which the Fed brought QE3 to a close., said former New York Fed President William Dudley.
"If you're generally satisfied with how it went last time, and I think they are, why not just follow the template unless there's a compelling reason to deviate?" he said.
HAWKS WANT FASTER TAPER
With Fed consensus building toward a year-end announcement on tapering, the FOMC will over the next several meetings hear staff briefings about the effects of the purchases and implications of different possible taper paths.
But already divisions are showing among those more optimistic about the speed of growth -- and pessimistic that higher inflation will prove transitory -- and others who see a more prolonged recovery. Seven of 18 FOMC members forecast lifting rates next year but there are five who still don't see a need to raise rates until after 2023.
The hawks will argue for a faster taper and options to speed up the process if inflation data comes in hot or to raise rates before the taper is complete. On the other hand, the economy could slow so much next year that disinflation resurfaces as a worry.
The heightened uncertainty over how the economy will finish out the Covid-19 recovery will also prompt the Fed to pledge to stand ready to adjust the pace of purchases if the outlook shifts, the ex-officials said.
"It really is going to be the case that it is not a smooth trajectory to zero with very low probability of deviating from that path," William English, former director of the division of monetary affairs at the Fed Board, told MNI. "That is the way that it turned out last time in 2013 because the economy continued to chug along as expected. Given the uncertainties, that may not happen this time."
A year-long taper without any special priority for mortgage-backed securities is a likely result, he added, but the Fed will be watching the economy closely and adjusting the pace if their fundamental view of the outlook changes.
UPSETTING THE APPLECART
Some FOMC members are eager to move to an all-Treasuries portfolio, given the booming mortgage market, but former officials told MNI the Fed leadership is hesitant to rock the boat and risk disruptions to a market accustomed to the Fed's presence.
"It just seems a little bit too much like tinkering with the innards of the economy to be doing it that way," said Steven Kamin, former director of the division of international finance at the Fed Board now a resident scholar at the American Enterprise Institute.
The FOMC has also argued that MBS purchases are not about supporting the housing market but more broadly help the economy by putting downward pressure on Treasuries and across the asset spectrum. To back away from that line of reasoning would be awkward.
"Even if it's the case that they don't taper MBS first, the fact that the rationale for MBS purchases is weak might mean that they'll lean toward tapering everything a little sooner rather than a little later," Kamin said.
Dudley agreed, saying there was no great argument to zero out MBS purchases any faster, despite the buoyant housing market.
"You've already established a template of how you do it, and last time you did them together," he said. "If you're going to do it differently this time, it raises questions like what else are you going to do different? So I'd be surprised if they do MBS first."