MacroScope

Will the Fed adopt thresholds for bond buys?

January 30, 2013

Tim Ahmann contributed to this post

Suddenly top Wall Street firms are talking about the possibility that the Fed might adopt numerical thresholds for asset purchases, in the same way it has done with interest rates more broadly.

Writes Mike Feroli, chief economist at JP Morgan and a former NY Fed staffer:

Perhaps the most interesting element of Fed policy at the current juncture is how they communicate the conditions that will lead to a slowing or a halt in asset purchases. The speed with which the Committee produced the numerical threshold rate guidance is a reminder that the Bernanke Fed can get their homework done early, but even so we do not look for any news on this front next week.

First, the discussion of this topic is still in its infancy; even the numerical threshold guidance took a few months of debate to finalize. Second, since the introduction of the Chairman’s press conference the FOMC has shown a strong preference to make big decisions – and ones potentially subject to public misunderstanding – at meetings associated with a press conference. There is no press conference scheduled for next week’s meeting. Third, given the complicated task of quantifying the costs of balance sheet expansion, it’s not even certain the Fed will ever communicate the economic conditions that would slow or stop their asset purchases.

What does Bernanke have to say about it? Here’s what he told us (or didn’t tell us) during his last press conference in December:

The goals of the FOMC’s asset purchases and of its federal funds rate guidance are somewhat different.  The goal of the asset purchase program is to increase the near-term momentum of the economy by fostering more-accommodative financial conditions, while the purpose of the rate guidance is to provide information about the future circumstances under which the Committee would contemplate reducing accommodation. [...]

The decisions to modify the asset purchase program and to undertake rate increases are tied to different criteria.

In December, the Fed implemented new policy guideposts for interest rates based on the path of unemployment. It vowed to keep rates near zero until the jobless rate, currently at 7.8 percent, falls to 6.5 percent, for as long as inflation is forecast to remain at or below 2.5 percent a year or two out.

Some of the Fed’s more dovish policymakers, like the Boston Fed’s Eric Rosengren, have argued for a similar approach on bond buying. But there are complications. For instance, if one of the Fed’s concerns regarding quantitative easing is that it might own too much of the Treasury market, then how can it commit to keep buying Treasuries ad infinitum?

Still, the talk was certainly making the rounds. Noted Kris Dawsey at Goldman Sachs:

While we believe that QE thresholds may be announced at some point this year, we would be very surprised to see them at the January meeting.

In addition to this handy summary of recent official comments on QE3, here’s a graphic illustrating individual policymakers’ forecasts for the likely timing of an eventual rate increase:

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