The Fed’s next test breaks the ice on policy change
WASHINGTON – As the economic recovery moves from forecast to reality, the Federal Reserve will be faced with a question that has vexed it in the past: how to signal its possible tightening of the monetary tap.
The process of ending the Fed’s giant bond-buying program, and subsequently raising interest rates, will take years unless inflation spikes unexpectedly. His first step down that road will be to start talking about it in the coming months or weeks – President Jerome Powell’s next big test with the financial markets.
Officials will begin by debating how and when to cut, or cut, the $ 120 billion and more in Treasury bonds and mortgages that the Fed has been buying each month since last June to lower borrowing costs. long-term.
That conversation has yet to begin, according to public comments from central bankers and the minutes of their March 16-17 political meeting. The Fed said in a post-meeting statement that the US labor market and inflation are expected to make “further substantial progress” before starting to cut its bond program. When asked at a press conference if it was time to start talking about cutting bond purchases, President Jerome Powell replied, “Not yet.”
At the time, economic forecasts called for a resumption of growth, but reliable data still reflected a slowdown during the winter outbreak of Covid-19. That has changed over the past six weeks, with data confirming some of the progress Mr Powell said he wants to see.
On April 14, Mr Powell took a small and subtle but important step in setting the parameters for the upcoming discussion, defining his purpose more clearly. The Fed will measure the progress of the economy “from last December, when we [first] announced this direction, ”rather than from March, when policy makers reiterated it, he said. This means that with each indicator of improvement, there is less ground to catch up.
It is a delicate matter for a central banker. The last time the Fed started telegraphing a reduction in asset purchases, in 2013, it sparked a bond market sell-off known as ‘taper tantrum’. Mr Powell, who was then part of a small cohort of governors looking to cut the program, was in the middle of the discussion. Yields on 10-year Treasuries, which directly affect long-term borrowing costs for consumers and businesses, have jumped by half a percentage point in just a month, rattling Fed officials who feared jeopardizing the recovery they were trying to foster.
The episode highlighted the delicate balance central bankers must strike when withdrawing support from the economy. Move too early and borrowing costs can rise sharply, undermining growth. Even talking about moving too early can hurt. Waiting too long – or even signaling a tendency to wait too long – and inflationary pressures can form or financial bubbles can appear.
Jeremy Stein, who served with Mr. Powell on the Fed’s board of governors during the inconvenience of 2013, said a lesson he learned from the episode is that there are limits to the ability to the central bank to calm the markets in a context of more stringent policy change.
“You are trying very hard, but it is very difficult to manage the volatility,” Mr. Stein said.
Mr Powell said he hoped to minimize the disruption this time around by giving the market enough notice before any changes to his bond buying plans.
Data released since mid-March shows that many more jobs have been created in recent months, although overall employment remains well below levels seen a year ago. Meanwhile, inflation has been higher than economists expected. A dramatic jump in retail sales has supported economists’ thesis that ending the pandemic restrictions will trigger a surge in pent-up consumer demand, fueling a strong recovery.
“I think the economy is poised to tear itself apart,” Fed Governor Christopher Waller said on April 16.
The US labor market remains at 8.4 million jobs below its pre-pandemic level, a figure Mr Powell often refers to to illustrate the distance that remains to be traveled for a full recovery. Welcoming the 916,000 jobs created in March, he said the Fed wanted to see “a series of months like this so that we can really start showing progress towards our goals.”
Since December, when the Fed set guidelines for rewinding bond purchases, the payroll has increased by $ 1.62 million. It’s certainly progress, although it doesn’t seem to meet the Fed’s mark of substantial. The unemployment rate fell from 6.7% to 6% but remains well above the level of 3.5% reached before the pandemic.
Fed officials have avoided giving a clearer definition of “substantial progress.” They are reluctant to confine themselves to a time of heightened uncertainty about the path of the economy.
Withdrawing money easily this time might seem different from the slow, carefully phased process that took place last time. After the 2007-09 recession, Washington officials focused on reducing budget deficits, which appeared to hold back growth, and inflation was brought under control. This time, billions of dollars of fiscal stimulus are flowing through households, businesses and local governments, fueling growth. Economists expect inflation to hit 3% by the middle of the year due to temporary factors and then decline.
Primary dealers polled by the New York Fed in March expected the central bank to start cutting bond purchases in the first quarter of 2022 and finish by the end of next year. The first interest rate hike, currently set at zero, would likely come some time later. Fed officials expect to leave rates unchanged until 2023, according to their own projections.
Write to Paul Kiernan at [email protected]
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