For the second time in less than a decade, the Federal Reserve is getting ready to launch a thorny debate over how and when to sunset a massive asset-purchase program that helped cushion an economy battered by crisis but left it with a mountain of bonds that may linger on its balance sheet for years to come.
Officials’ opening discussion about how and when to taper the US central bank’s $120 billion in monthly bond purchases looks set to occur at this week’s two-day policy meeting and will take place against a dramatically different backdrop than the last time around, when they were more skittish about owning such a substantial slice of the bond market.
“I think the discussion will start” at the Fed’s policy meeting on Tuesday and Wednesday, said Robin Brooks, chief economist at the Institute of International Finance. “I think it will start very, very cautiously,” he added, and Fed Chair Jerome Powell won’t be in any rush to conclude it.
The risk of another “taper tantrum” – the market ruckus that erupted eight years ago when Fed policymakers first broached the notion of scaling back their bond-buying after the 2007-2008 financial crisis – appears remote this time. Fed officials have posted plenty of trail markers for the path to tapering, and key officials have signaled the discussion is underway in the background. Markets so far have taken it all in stride.
The Fed said in December that it would continue to buy $80 billion in Treasuries and $40 billion in mortgage-backed securities (MBS) each month until the economy made “substantial further progress” towards the central bank’s full employment and 2 percent inflation goals. The bond-buying puts downward pressure on longer-term borrowing costs to encourage investment and hiring.
While there has been plenty of progress in slowing the coronavirus pandemic, largely due to a widespread vaccination program, US employers have added fewer than half of the 2 million jobs that Powell had suggested he was hoping for after the Fed’s April policy meeting.
Fear of contracting the virus, a pandemic-driven job market reshuffle and extra unemployment benefits are among the factors keeping workers from jobs even as firms try to staff up ahead of an expected summer boom. More than 9 million Americans are unemployed.
Meanwhile, inflation has come in hotter than expected, though the gains have been driven by factors that are expected to be transitory, such as the global semiconductor production bottleneck.
“We have a lot of weird things going on right now,” said Alejandra Grindal, chief international economist at Ned Davis Research. “It will take quite a few months until these issues become resolved and we can determine whether they are more than transitory.”
Most economists in a Reuters poll released last week said they expected the Fed to take until at least August to flag a timeline for tapering, with no actual reductions in asset purchases until early next year.
Compared with the last time the Fed was contemplating reducing its bond purchases, the US economy is arguably in better shape. The unemployment rate is lower, overall national output is closer to its pre-crisis trend, and stronger tailwinds, including $2.8 trillion of pandemic-related government aid in the past six months, are setting up what’s expected to be the fastest economic growth in decades this year.
