MNI STATE OF PLAY: Fed Stays Patient as Outlook Improves

The Federal Reserve on Wednesday will reiterate that it remains far from hitting its employment and inflation objectives and that it will be some time before it starts winding down QE, even as upgraded forecasts are likely to show officials moving forward the timing for pulling back policy support.

Investors betting on an "Operation Twist"-style switch from shorter-dated to longer-dated bond buying to cap a spike in Treasury yields are likely to be disappointed, former officials told MNI, although the FOMC could raise the rates it pays on excess reserves and overnight repurchase agreements to support short-end rates as the Treasury releases over a trillion dollars in reserves into the financial system.

Fed Chair Jay Powell will likely stick to his message that higher yields reflect an improving economic outlook. With rates already effectively at zero and the Fed purchasing USD120 billion per month, the central bank is loath to intervene further in bond markets, former officials said.

Last week's passage of President Joe Biden's USD1.9 trillion coronavirus relief package and progress on vaccinations are set to lift FOMC estimates for GDP growth and employment over the medium term. The median forecast for raising rates could shift forward to 2023, with potentially more than one official penciling in a hike as soon as next year, former Fed officials told MNI.

EARLIER TAPER

Treasury Secretary Janet Yellen has projected the stimulus will allow the economy to hit full employment in 2022, making it plausible the labor market could make "substantial further progress" by year-end -- the bar set by the FOMC for winding down asset purchases.

Former officials told MNI the Fed could signal the start of a debate over QE taper as soon as this summer.

In the meantime, former Fed officials told MNI the central bank will likely bump up both the IOER and ON RRP rates in the next few months to keep its benchmark fed funds rate trading comfortably above zero as the Treasury releases over a trillion dollars in reserves into the financial system.

Raising the Fed's administered rates is viewed as a technical adjustment and some officials may prefer to wait until the effective fed funds rate sinks to 5 bps from 7 bps currently.

Regulators could also extend a temporary exclusion of reserves and Treasuries from banks' calculations of the Supplementary Leverage Ratio for several months, amid recent turmoil in Treasuries trading, but the decision is one for the Fed Board in conjunction with other bank regulators and may not come at Wednesday's meeting.