Fed exit outlines – slower buying, no selling

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The WSJ’s Hilsenrath just published a review of the debates being had about how the Fed steps back from its current policy stance (85bn per month of bond buying). The two topics for debate are the pace of purchases — an active debate right now — and how to move away from balance sheet policies and back to interest rate only policy — one that hasn’t formally begun.

It seems the mood is swinging toward slower purchases, with the bonds held until maturity rather than sold down after the funds rate moves away from zero.

Here’s my edited extract from Jon’s note:

Two developments are worth watching on the Federal Reserve front these days.

Call the first the tapering debate. Right now the Fed is buying $85 billion per month of U.S. Treasury debt and mortgage-backed securities. It has said it would continue to buy this debt until it sees substantial improvement in the outlook for employment.

Given the Fed’s high degree of uncertainty about its policies and the economic outlook, tapering would give officials a chance to calibrate their moves, and learn as they are doing so. Tapering also has the benefit of relieving financial markets of sharp moves.

Although this doesn’t appear to be settled as the strategy of choice, a number of officials have alluded it recently. The Fed tapered the end of its first round of Treasury and mortgage backed securities purchases in 2009 and 2010; it ended its second Treasury purchase program without tapering.

The second strategic issue for the Fed is the sequencing of its exit strategy. In June 2011, Fed officials came up with a plan for eliminating the central bank’s holdings of mortgage backed securities over time.

“We should definitely be reviewing that exit strategy,” Mr. Williams said. Several people familiar with the matter said a formal review hasn’t started yet.

Under one approach bubbling up, the Fed wouldn’t sell down its securities holdings as aggressively as previously envisioned. Such an approach could make for a kinder and gentler exit by the Fed from its easy money policies. Rather than sell securities–which could unsettle markets–it could allow its portfolio to wind down slowly as mortgages are paid off and the securities mature.

An added benefit: Holding the mortgage-backed securities to maturity might help the Fed avoid selling its holdings at a loss. The approach would “address concerns over potential market disruption from the sale of off-the-run mortgage backed securities,” Fed Governor Jerome Powell said in a speech Friday. “And it would also smooth remittances” of Fed profits to the U.S. Treasury.

The fact that Fed officials are talking about tapering and exit doesn’t mean that they are about to turn off the spigot. Many officials still want to keep the Fed’s pedal pressed to the floor–an analogy used by Fed vice chairwoman Janet Yellen recently.


  1. To explain the fact that QE infinity is now being heavily debated, all of a sudden really, have you thought about the possibility of international pressure on the Fed, before and during the G20 ?

    I mean it would make sense. The USD has been too weak for 5 years now… and so the pegged Renminbi… the EUR is definitely too strong: 20% depreciation at least is needed and it would solve lots of issues in the euro zone, much more than austerity can do. AUD soon to be a major drag if not depreciating, Yen the same… Pound…. It is time for the US and China to stop this or Draghi will peg the EUR to USD parity.

    1. This had not occurred to me, but it is certainly possible that it came up at the G20. I imagine the japanese were keen to point out that the BoJ’s proposed course of action was modest compared to what the fed had committed to.

      1. The situation in some European country is quite severe. Unemployment higher than in the US, spending is down, debt over GDP is higher; they need a lower currency much more than the US does. But, somehow, they are silently accepting a EURO that is much too strong? Germany should realize Europe needs a lower currency not austerity right now.

      2. Unlimited QE in Europe too…. or even pegging EUR to USD? German exports would benefit too. If inflation is a problem for Germany (I think they are a long way from that) then they can use fiscal measures for controlling inflation instead of monetary policy, like more austerity in Germany instead of the periphery. Surely there needs to be a central bank in Europe that is as proactive as the one in the US! I am sure not all states in the US would need the same monetary policy, but the majority wins.

        1. It is the fiscal transfers that soften the blunt edge of monetary policy – in Europe they do not yet have that, so it puts all the pressure on the budgets to adjust (which is tough, as they have inflexible markets).

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