On Wednesday January 6th the Federal Reserve released the minutes of the December 2020 FOMC policy meeting.
The meeting's plans for future revisions to the 'quantitative easing' program were closely watched, with the minutes showing that the proposal to increase the duration of bond purchases did not receive much support from officials. The word "taper" was prominent in the Powell Fed papers this time around, with Morgan Stanley noting that the Federal Open Market Committee (FOMC) had begun to envisage a gradual tapering of QE.
The minutes noted (note: The Wall Street Sketch is highlighted in quotes) :
Meeting in December, all participants will strengthen the FOMC guidance of asset purchases, especially the "based on the results of qualitative guidance", suggests that asset holdings will continue to increase, a month to buy at least $80 billion of U.S. Treasury bonds and at least $40 billion of agency MBS, until to realize double goals of maximum employment and price stability "substantive progress" further.
A few participants emphasized that all of the Fed's policy tools are currently well positioned to respond to economic developments. If the dual objectives are achieved more slowly than expected, the latest forward guidance could add to the amount of monetary easing by keeping the base rate at current levels for longer and raising the expected path of the balance sheet. In this context, it is important to communicate to the public that the federal funds rate remains the Fed's main policy priority, a couple of participants noted.
A number of participants discussed how to determine the criteria for "substantial further progress". They believe the criteria will be "broad and qualitative, rather than based on specific numerical criteria or thresholds". It is important, several participants noted, for the FOMC to clearly communicate to markets its assessment of actual and expected progress toward its long-term goals "well in advance" of its judgment that any changes to the bond-buying program can be made.
In terms of the pace of purchases and bond composition, "all participants" agreed that continuing purchases at least at the current pace was appropriate, "nearly all" favored maintaining the current bond composition, and "only a couple of participants expressed an openness" to increasing purchases of longer-dated bonds.
Some participants noted that the FOMC could consider future adjustments to its asset purchases, such as an increase in the pace of bond purchases or purchases of longer-dated Treasury securities, but only if those adjustments were deemed appropriate to support the Fed's dual objectives. A few officials stressed the importance of continuing to assess the balance between the costs and risks of bond purchases and the benefits they generate.
A number of participants noted that once substantial further progress towards employment and price targets had been made, the "tapering" of bond purchases could begin, after which the procedures put in place after the massive purchases of 2013-14 could be broadly followed.
The language of the minutes was consistent with what Fed Chairman Colin Powell said at a press conference after the FOMC meeting on Dec. 16. Mr Powell said at the time that interest rates would not rise until inflation was back on track, and reiterated that the Fed could expand its bond purchases and adjust the duration of the bonds it buys, and that it would inform markets well in advance of tapering.
In its December FOMC post-meeting statement, the Fed strengthened the language of its forward guidance for bond purchases, one of the biggest changes to the statements from the four meetings. The latest guidance makes clear that "the Federal Reserve will purchase at least $120bn of Treasury and agency MBS per month until substantial further progress is made towards achieving the objectives of full employment and price stability. The August to November statements all referred to "purchases of Treasury securities, agency MBS and commercial mortgage loans at at least the current pace in the coming months to maintain the smooth functioning of the market".
With the Fed consensus expecting benchmark interest rates to remain at a record low near zero until 2023, asset purchases have become a major lever to increase or reduce monetary stimulus, analysts say. Ahead of the December FOMC meeting, many expect a faster pace of bond purchases or a longer duration, which could stimulate the economy by lowering long-term interest rates.
But Mr. Powell said in December that the Fed did not believe that was appropriate at this time because long-term interest rates were already low, giving a boost to sectors of the economy such as housing, interest-sensitive parts of the economy that were doing well, and areas that were underperforming because of the outbreak, not because they were struggling with high rates. He has also been arguing that fiscal stimulus is the appropriate response to the recent deterioration in the economic outlook.
The Fed's revised forward guidance on bond buying, and the December minutes' reference to "following 2013 and 2014 procedures", are intended to avoid a repeat of the 2013 "taper tantrum" in bond markets. At the time, then-Fed Chairman Ben Bernanke suggested the central bank might reduce its asset purchases as soon as possible, which investors interpreted as the Fed was accelerating its plans to raise interest rates. That triggered a brief jump in the yield on the benchmark 10-year Treasury note by as much as 1 percentage point (100 basis points) and a 7 percent drop in U.S. stocks, sending markets around the world into turmoil.
So how did the Fed shrink its balance sheet after 2014? Since October 2014, the Federal Reserve announced that it would stop buying new financial assets and only reinvest the maturing principal. Since October 2017, the Fed has officially reduced its assets:
Reinvest the Treasury at a monthly limit of $6 billion, increasing by $6 billion every three months over 12 months, up to the $30 billion limit; Agency MBS will initially reduce the cap by $4 billion a month and increase it by $4 billion every three months until the $20 billion cap is reached. By October 2018, the combined cap on the Fed's monthly reductions in Treasury bonds and agency MBS reinvestments rose to $50 billion a month, which will remain until the balance sheet reduction ends.
In addition, December FOMC participants continued to view risks surrounding the economic outlook as high and highly dependent on the progress of the outbreak. Positive news of the new crown vaccine is seen as reducing the downside risk in the medium term. Despite the FOMC's upward revision of its GDP growth forecast for the United States through 2023, participants saw significant uncertainty about the pace of vaccine deployment and how the public will respond to vaccine availability, which in turn creates downside risks that threaten the economic recovery.
Notably, while there is a broad consensus among Fed officials about keeping interest rates at historically low levels, there is no consensus on when to reduce "quantitative easing" asset purchases. Cleveland Fed President Jon Mester said this week he did not think tapering would be possible before 2022, but Atlanta Fed President Bostic, a FOMC vote member in 2021, said it could be done this year if the spread of vaccines improves the economic outlook. Thus, it is uncertain whether FOMC participants in 2021 will continue to "unanimously support" the bond-buying topic.
Gold, U.S. stocks and the dollar were little changed after the Fed minutes were released. Bitcoin rose in the short term, rising above $35,600, according to Bitstamp. Before the minutes were released, spot gold was at $1911.15, down 2 percent on the day; The dollar index was at 89.48, down 0.01% on the day; The Dow gained 589 points, the Nasdaq gained 0.59%, and the S&P 500 gained 1.39%.