Revenge of the Fed hawks – sort of

January 4, 2013

Gabriel Debenedetti contributed to this post

Federal Reserve officials appear to be getting cold feet. Having just announced an open-ended bond buying program in September and then broadening it in December, minutes from last month’s policy meeting suggested an increasing caution about additional monetary stimulus among the Federal Open Market Committee’s core of voting members.

Several (members) thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet.

That’s considerably quicker than investors had in mind. Stock and bond markets recoiled at the prospect.

Many analysts noted key figures like Chairman Ben Bernanke and his number two and potential successor Janet Yellen have often spoken out in favor of QE and argued Fed policy is having a positive effect. Says Eric Stein at Eaton Vance in Boston:

I still think the core of the FOMC will be very aggressive on the monetary easing side unless they are fully convinced that we are in a strong sustainable recovery or there is a significant pickup in inflation.

Hawkish regional Fed presidents have long had issues with unconventional policy tools. Dallas Fed President often jokes that he is proud to be seen as a hawk because doves “are part of the pigeon family.” (See Fed hawks-doves graphic here)

Richmond Fed President Jeffrey Lacker, speaking to a group of bankers in Maryland, dug in his heels in opposition to QE3:

At some point, we will need to withdraw stimulus by raising interest rates and reducing the size of our balance sheet, and the larger our balance sheet, the more vulnerable we will be to seemingly minor miscalibrations in policy. Accordingly, I see an increased risk, given the course the Committee has set, that inflation pressures emerge and are not thwarted in a timely way. I intend to remain alert for signs that our monetary policy stance needs adjustment.

Nonetheless, it was hard not to sense a distinct change in tone from the December minutes. Here are a few comments from economists that captured the shift in market sentiment.

Julia Coronado, a former Fed economist now at BNP Paribas:

The bottom line is that the policy is likely to be in place for a while, but the minutes seem to be raising some doubts about the commitment to the policy.

Millan Mulraine, senior economist at TD Securities:

This is somewhat earlier than what the markets would have thought going into this report, and while the evolution in the data, particularly progress in the labor market, will ultimately determine the timing of the end point for purchases, it seems reasonable to assume that the Fed has penciled in some time in 2013 as a natural point to conclude the QE3 program.

Pierre Ellis, senior economist at Decision Economics:

There’s evidently less agreement about the cost-benefit profile that will develop as purchases continue. Some members seem to be very cautious about that, while others are willing to pursue the policy almost indefinitely.

The committee as a whole is not as hell-bent on easing as might have been assumed and they want to let us know that the cost-benefit trade-off is meaningful.

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