Fed wrangles over speedier exit of pandemic-era stimulus

Federal Reserve officials held a vigorous debate last month on whether the economic rebound in the US would soon be strong enough for the central bank to start dialling back its pandemic-era stimulus more quickly than expected.

Minutes from the June meeting of the Federal Open Market Committee meeting released on Wednesday showed two prevailing camps wrangling over whether the US economy was ready for a speedier reduction of its $120bn asset purchase programme.

That debate is expected to take centre stage in the coming months.

Fed officials hinted that “tapering” of the purchases may start earlier than expected given the stronger economic outlook, buoyed by the fast US vaccination rollout, but conditions were not quite ripe yet.

“The committee’s standard of ‘substantial further progress’ was generally seen as not having yet been met, though participants expected progress to continue,” the minutes said.

“Various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings in light of incoming data.”

Some officials urged caution, however, in reading too much into the current data, given potential quirks associated with the economic reopening. Information in the coming months would allow for a “better assessment of the path of the labour market and inflation”, they said.

The committee generally agreed that “as a matter of prudent planning, it was important to be well-positioned to reduce the pace of asset purchases, if appropriate, in response to unexpected economic developments”. 

The Fed decided to keep its main interest rate on hold close to zero, but officials forecast that they would increase rates in 2023, earlier than anticipated in March. Those projections, in a document commonly known as the “dot plot”, were discussed during the meeting.

According to the minutes, “a few” officials said they expected the economy to be ready for interest rate rises “somewhat earlier” than previously thought, but others pushed back.

“Several participants emphasised . . . that uncertainty around the economic outlook was elevated,” the minutes said, and that “implied significant uncertainty about the appropriate path of the federal funds rate”.

Some Fed officials also warned that given the market’s attention to the interest rate projections “it would be important to emphasise that the committee’s reaction function or commitment to its monetary policy framework had not changed”.

The Fed has said it would only increase interest rates once full employment was attained and when inflation had reached 2 per cent and was on track to exceed it moderately for some time.

Some investors interpreted the new interest rate projections as an indication that the Fed may prove more responsive to inflationary pressures than previously expected, prompting a sharp rally in US government bond prices since the meeting. The yield on the benchmark 10-year note had fallen by Wednesday to 1.3 per cent, the lowest level in four months. 

The ultra-long 30-year bond was steady at about 1.93 per cent after publication of the minutes, well off of the 2.3 per cent level seen at the start of June.

Fed officials also discussed last month how the central bank would go about scaling back its asset purchases, when they eventually deem it appropriate. A growing chorus of officials have publicly voiced their preference for ending purchases of agency mortgage-backed securities sooner than the Treasury bond buys, a view underscored in the minutes.

“Several participants saw benefits to reducing the pace of these purchases more quickly or earlier than Treasury purchases in light of valuation pressures in housing markets,” it said.

Not all officials subscribe to this view.

“Several other participants, however, commented that reducing the pace of Treasury and MBS purchases commensurately was preferable because this approach would be well-aligned with the committee’s previous communications or because purchases of Treasury securities and MBS both provide accommodation through their influence on broader financial conditions,” the minutes said.