Fed: “Wait and See”

Published on January 13, 2021

Federal Reserve Bank President Esther George gave something of a shrug to questions about the timing to a taper of the Federal Reserve’s asset purchases in a webcast interview yesterday, describing the current policy stance as “the wait and see approach.”

** Both Vice Chairman Richard Clarida later today and Chairman Jerome Powell tomorrow are very likely to reaffirm that messaging, pushing back on the speculation over the timing to a reduction in the pace of the Fed’s current $120 billion a month in treasury and MBS purchases.

** Changes to the current balance sheet policy will depend on the evolution of the data and the economy — and, we would add, the scope and scale of fiscal policy under the Biden Administration. The eventual change in balance sheet policy will be outcome-based not date-driven, and in any case, it will be well telegraphed in a long runway of messaging to avoid a repeat of the 2013 taper tantrum messaging misfire.

** And until the Federal Open Market Committee reaches a consensus on BSP – we think it unlikely much before June at the earliest — each member is free to offer his or her opinion on taper scenarios. Atlanta’s Rafael Bostic has perhaps been the most surprising, in being unusually vocal in noting the taper could and probably should come later this year. His more hawkish sounding take is more or less echoed by Dallas President Robert Kaplan, who adds an overlay of concern over financial stability risks in a prolonged period of low rates and heavy asset purchases.

** In Bostic’s case, our sense is that he is seeking to position market expectations to be better braced for what his district believes with an increasing confidence will be a strong second half rebound, while Kaplan’s anxieties over market excesses are in fact widely shared across a Committee keeping an eye for financial dislocations or excess leverage and valuations. There is nothing to suggest the current range of views will not fall into a solid Committee consensus on balance sheet policy down the road this year.

** We doubt in fact that the Fed will make a move on balance sheet until they see how far the Biden Administration and Congress go on fiscal policy and whether the race to get people vaccinated goes faster and more smoothly than so far. Indeed, our sense is that even amid a rising optimism on the second half outlook, many if not most Fed officials remain cautious over downside risk in that while a lower probability, if things do go south, the cost and demands on policy will be prohibitive and test the very limits of monetary policy.

** In the meantime, for the majority of the Committee, especially the Board, the recent rise in yields and inflation expectations is more or less welcomed in reflecting a greater optimism over the growth outlook in the second half of this year. That was, after all, the whole point of the new policy framework.

** In the same vein, our sense is that Fed officials do not see the recent price movements as a questioning of their guidance or its newly defined reaction function, but rather a desirable debate over the Fed’s Summary of Economic Projections. What’s more, yields and the spread are coming off extremely low levels, putting the recent upward moves more or less in line with a “normalizing” bond market.

** If, on the other hand, there are deepening doubts over the credibility of the Fed’s rates guidance, it would invariably draw a more concerted messaging offensive. But a doubling of yields like in the infamous taper tantrum over the summer of 2013, this is not. For now, Fed officials will be more or less content to see the market pricing that has the look of a return to price discovery seemingly buried under the Fed’s years of policy activism.

** We would only add that we still think a base case scenario – though for now it is only just that, a scenario – is for a “two phase” balance sheet policy shift at some point later this year (SGH 1/8/21, “Fed: Until the Economy Says No”): that is, a first step with a weighted average maturity shift in the asset purchases to longer term treasuries to ensue ample accommodation as the economy gathers momentum but using the moment to make a one-off decrease in the pace of monthly asset purchases.

** In turn, that lower pace of QE but a more muscular easing to temper a premature or too steep a rise in yields would be followed by the much discussed very gradual tapering of QE as the economic recovery gathers a sustained momentum that marks the “substantial further” progress towards achieving the Fed’s twin mandates.

** But again, it will just depend on the progression of the vaccine and virus, the evolution of the economy, the scale of fiscal policy support, and the pace and sustainability of the expected rebound in the second half of this year. That, almost by definition, pushes any consideration of changes in balance sheet policy to June at the earliest, and probably not until September.

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