Federal Reserve Chairman Jerome Powell on Wednesday suggested the Fed would follow the same playbook it developed in 2013 and 2014 once it decides to reverse its asset-purchase program, meaning a tapering of asset purchases would come “well before” any interest-rate increase.
The Fed is currently in emergency-policy territory that began when the coronavirus pandemic hit the economy last spring. The central bank cut its policy interest rate to zero last March and pumped billions into financial markets to prevent a financial crisis.
Since last summer, the Fed has been buying $80 billion in Treasurys and $40 billion in mortgage-backed securities each month to boost the economy and keep financial market conditions on an even keel.
In a moderated discussion sponsored by the Economic Club of Washington, Powell was asked for the sequence of any future exit from the Fed’s current monetary-policy accommodation.
The Fed chairman said the central bank would likely taper asset purchases “well before the time we consider raising interest rates.”
“We haven’t voted on that order, but that is the sense of the guidance that it would work in that way,” Powell said.
The comments fill in some gray areas for economists seeking to gauge the Fed’s plans for the inevitable exit. Economists are predicting the U.S. economy will roar back to life this year, with gross domestic product perhaps hitting a 10% annual rate in coming quarters.
That was the same policy playbook the central bank followed in 2013 and 2014. The Fed started tapering asset buying in December 2013 and didn’t raise interest rates for two years.
Asked when the Fed would taper, Powell would not give any calendar date for a shift in policy — saying it would depend on the state of the economy.
The Fed has said it won’t taper the size of the purchases until it has seen “substantial further progress” on its goals of maximum employment and stable 2% average inflation. It has said it would not raise interest rates until the economy is back to full employment, inflation has reached 2% and is on track to be moderately above 2% for some time.
After the financial crisis of 2008, “we were buying assets and then we gradually slowed the pace at which we were buying Treasurys and mortgage-backed securities,” Powell said.
“When the purchases go to zero, the size of the balance sheet is constant and when bonds mature, you reinvest them,” he said.
Any decision to actually shrink the balance sheet is “another step” that happened “late in the day in the last cycle” — when the Fed allowed bonds to start to run off, Powell noted. As of today, he said, “we haven’t decided whether to do that or not.”
Also, the Fed didn’t sell bonds from its balance sheet into the market during the last cycle, and Powell said he didn’t think the Fed would do that this time either.
The Fed’s balance sheet is now more than $7 trillion.
Economists generally think the Fed will begin to taper its asset purchases early next year. Any interest-rate hike might not come for another year. But a vocal minority think the Fed might have to tighten sooner.
At the moment, the bond market BX:TMUBMUSD10Y seems content with the story according to which the first rate hike won’t come before late 2022 or 2023. At the Fed, 11 of the 18 senior policy makers don’t see the first hike until after 2024.
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