Fed Watch: Tapering talk spawns Treasury sell-off
The Fed isn’t ready to act yet but may start pulling back on Treasury and agency purchases by fall and end them by the middle of next year. That announcement, not contained in the policymakers’ official post-meeting statement but made by Fed Chairman Ben Bernanke in his press conference afterward, caused 10-year Treasury yields to spike this afternoon, closing at 2.34%, their highest in more than a year.
The run-up came even as Bernanke took pains to signal a hesitancy to act quickly or significantly. Indeed, Bernanke emphasized there could be considerable time between tapering and a tightening. The former represents a slowing in the current $85 billion of monthly purchases of Treasury and agency mortgage-backed securities (MBS), while the latter represents actual increases in the target federal funds rate. Looked at another way, Bernanke likened tapering to easing off the accelerator, which he said will begin if the economy achieves sufficient cruising speed to grow without additional monetary accommodation. Increases in the benchmark funds rate, on the other hand, are akin to applying the brakes, and that won't likely start until “far into the future.’’ He noted 14 of the 19 Fed policymakers don’t expect fed fund rate increases to begin until 2015; one doesn’t expect any until 2016 at the earliest. When they do start to come, Bernanke said, the increases are likely to be gradual and small, more like a gentle tapping on than a slaming of the brakes.
Still, the markets focused on the tapering talk and the generally more upbeat economic picture painted by the policy-setting Federal Open Market Committee (FOMC). In the statement, there was no mention of the impact of the fiscal drag of sequestration, which had been cited in previous statements, and an acknowledgement that the housing sector continues to strengthen and labor market conditions continue to improve (policymakers are now forecasting the unemployment rate to reach 6.5% next year, instead of 2015 as previously estimated). While it lowered its forecast for future inflation, which some have suggested could buy the Fed more time before starting to let off the gas, the Fed’s statement indicated these price trends partially reflect transitory influences and that longer-term expectations remain stable.
Bernanke did take pains to note that the economy remains sufficiently weak to justify continuing with QE through mid-2014, when the Fed projects the unemployment rate will have fallen to 7%. He also made clear that tapering is data dependent: if growth falters, the Fed’s timetable to begin scaling back asset purchases could be delayed. Given the Fed’s balance sheet will continue to expand until QE ends—holdings of Treasury and agency MBS already more than tripled the size of the Fed’s balance sheet since the first wave of QE purchases started four years ago—QE should act to tamp down longer rates even as it moderates purchases, Bernanke said. He added that a broad majority of FOMC members also prefer holding onto and not selling the MBS it has acquired, a move that likely would prove supportive for housing.
It’s worth noting that there were two opposing dissenters on the direction of policy. Kansas City Fed President Esther George, an inflation hawk, voted against continuing with QE on concerns it may fan future inflation. St. Louis Fed President James Bullard, a dove, was concerned the policy didn’t go far enough to protect against potential deflation.