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.