Federal Reserve policy makers are signaling they favor an abrupt end to $600 billion in Treasury purchases in June, jettisoning their prior strategy of gradually pulling back on intervention in bond markets.
“I don’t see a lot of gain to reverting to a tapering approach,” Atlanta Fed President Dennis Lockhart told reporters yesterday. “I don’t think that is necessary,” Philadelphia Fed President Charles Plosser said last month. Central bankers, who next meet March 15, are about half way through their second round of bond purchases. To bring the program to a full stop in June, they must be confident that the economy is strong enough to endure higher long-term interest rates and rising expectations of an exit from the most expansive monetary policy in Fed history, said Dan Greenhaus at Miller Tabak & Co. LLC in New York. “If this is a self-sustaining recovery that can withstand higher interest rates, then why not get the hell out?” said Greenhaus, Miller Tabak’s chief economic strategist. “Still, I am nervous about their ability to withdraw from this policy without broader disruptions.” The Fed announced in November that it would buy $600 billion of Treasuries through June in a bid to boost the recovery and reduce an unemployment rate lingering near a 26- year high. The program, known as QE2 for the second round of so- called quantitative easing, followed $1.7 trillion of asset purchases that ended in March 2010.
Stock Versus Flow
Fed staff members, such as Brian Sack, the New York Fed official in charge of carrying out the bond buying, have argued the total amount, or stock, of securities the Fed has announced it will make has more impact on longer-term interest rates than the timing of those purchases. That’s a view now held by several members on the Federal Open Market Committee, including the chairman. “We learned in the first quarter of last year, when we ended our previous program, that the markets had anticipated that adequately, and we didn’t see any major impact on interest rates,” Fed Chairman Ben S. Bernanke told the Senate Banking Committee during his March 1 semiannual monetary-policy testimony. “It’s really the total amount of holdings, rather than the flow of new purchases, that affects the level of interest rates.” Fed Vice Chairman Janet Yellen supported that perspective, saying at a monetary policy forum in New York last week that “the stock view won out over the flow view.”
The New York Fed is buying around $80 billion a month in Treasuries, according to estimates by Wrightson ICAP LLC. Yields on U.S. 10-year notes were at 3.56 percent yesterday, about a point higher than when the program began, as the economic outlook improved. An end to Treasury purchases may not signal that tighter monetary policy is imminent. The Fed won’t raise its benchmark interest rate from close to zero until the first quarter of 2012, according to a Bloomberg News survey of economists early last month. One reason is that inflation remains below the Fed’s long run objective of about 2 percent. By contrast, mounting inflation pressures in Europe prompted European Central Bank President Jean-Claude Trichet yesterday to say the ECB may raise rates next month for the first time in almost three years. Stretching out Treasury purchases past the end of June while reducing the monthly amount would help bond dealers adjust to the Fed’s withdrawal from the market, said Lou Crandall, chief U.S. economist at Wrightson ICAP in Jersey City, New Jersey.
“The risk of stopping suddenly on July 1 is that the Treasury underwriting process is messy as Wall Street starts to absorb large amounts of additional debt,” said Crandall. Such concerns prompted Bernanke in August 2009 to slow purchases under the first $300 billion Treasury-buying plan while extending it by one month. In September 2009, the central bank made a similar move on its $1.25 trillion in mortgage- securities purchases, delaying the end-date to March 2010 from December 2009. At the time, the economy was still in the early phases of recovery. The expansion is now in its seventh quarter, and Fed officials see fewer risks. The low end of their range of growth forecasts for 2011 moved up to 3.2 percent in January from 2.5 percent in November. Bernanke, in his testimony to lawmakers this week, cited rising equity prices and narrowing corporate bond spreads as evidence of the success of the bond purchases. The Standard & Poor’s 500 Index has climbed 25 percent since Aug. 27, when Bernanke first signaled the Fed was prepared to launch QE2. Recent economic data suggest that the world’s largest economy is gaining strength.
Jobless claims unexpectedly declined last week to the lowest level since May 2008, and service industries expanded at the fastest pace since 2005, reports yesterday showed. Manufacturing in February grew at the fastest pace in almost seven years, according to the Institute for Supply Management. Slowing the rate of purchases and extending them a few weeks past June would give the Fed added flexibility in case the 36 percent rise in oil prices in the past six months deals a blow to the recovery, said economists such as Julia Coronado. “The party has to continue” for Fed officials to end the program in June, said Coronado, the chief economist for North America at BNP Paribas in New York. “They have to continue to see substantial strength in jobs, growth, and financial market conditions.” Economists such as Joseph Lavorgna say the Fed should stick to its commitment to end the program in June.
“What markets would like are clear rules,” said Lavorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. “If they said they are going to end in June, they should end in June.” That’s a view shared by the Philadelphia Fed’s Plosser, who is a voting member of the FOMC this year. “Barring a change in policy or a change in economic conditions, we have already communicated what is going to happen,” Plosser told reporters Feb. 23. The Atlanta Fed’s Lockhart said officials can help prepare markets for an end to the program. “It is important that we communicate so we don’t surprise markets, regardless of the chosen path of that particular policy,” he told reporters yesterday after a speech in Tallahassee, Florida.