Fed officials are arguing over the quicker withdrawal of stimulus during the pandemic
Fed officials had a heated debate last month on whether the U.S. economic rebound will be fast enough for the Fed to begin to withdraw its pandemic stimulus measures faster than expected.
The minutes of the June meeting of the Federal Open Market Committee released on Wednesday showed that the two camps are arguing over whether the economy is ready to accelerate the reduction of the $120 billion asset purchase plan.
This debate is expected to become the focus in the coming months.
Fed officials hinted that given the stronger economic outlook driven by the rapid vaccination in the United States, “scaling” purchases may begin earlier than expected, but the conditions are not yet ripe.
The minutes of the meeting stated: “The committee’s criteria for’further substantive progress’ are generally considered to have not been met, but participants are expected to continue to make progress.”
“A number of participants mentioned that, given the upcoming data, they expect the conditions to start reducing the pace of asset purchases will be earlier than they expected in previous meetings.”
However, given the potential quirks associated with the reopening, some officials urged careful reading of current data. They stated that the information in the coming months will help “better assess the trends in the labor market and inflation.”
The committee generally agreed that “as a matter of prudent planning, it is important to be prepared to reduce the pace of asset purchases under appropriate circumstances in response to unexpected economic developments.”
The Fed decided to keep the main interest rate close to zero, but officials predict that they will raise interest rates in 2023, earlier than expected in March. These forecasts were discussed during the meeting, in a document commonly referred to as a “dot graph”.
According to the minutes of the meeting, “some” officials stated that they expected the economy to prepare for a rate hike “slightly earlier” than previously expected, but others objected.
“Several participants emphasized… The minutes of the meeting stated that the increased uncertainty surrounding the economic outlook means that there is significant uncertainty about the appropriate path of the federal funds rate.
Some Fed officials also warned that given the market’s focus on interest rate forecasts, “it is important to emphasize that the committee’s response function or its commitment to its monetary policy framework has not changed”.
The Fed has stated that it will raise interest rates only when full employment is achieved and the inflation rate reaches 2% and is expected to moderately exceed it for a period of time.
Some investors interpreted the new interest rate forecast as an indication that the Fed’s response to inflationary pressures may be more sensitive than previously expected, prompting the price of US government bonds to rise sharply since the meeting. As of Wednesday, the benchmark 10-year Treasury bond yield has fallen to 1.3%, the lowest level in four months.
After the announcement of the meeting minutes, the yield on the ultra-long-term 30-year bond has stabilized at around 1.93%, far lower than the 2.3% level in early June.
Fed officials also discussed last month how the central bank will reduce the scale of asset purchases when they finally see fit. More and more officials have publicly stated that they tend to end the purchase of institutional mortgage-backed securities earlier than the purchase of treasury bonds. The minutes of the meeting emphasized this view.
“Given the valuation pressure in the real estate market, some participants have seen the benefit of slowing down these purchases faster or earlier than buying Treasury bonds,” it said.
Not all officials agree with this view.
“However, several other participants commented that it is advisable to reduce the purchase of Treasury bonds and MBS accordingly, because this method will be fully consistent with the previous communication of the Committee, or because the purchase of Treasury bonds and MBS are both passed on the broader financial It’s the impact of the situation to provide convenience,” the meeting minutes said.