Fed Favors Strategy of Raising Rates Before Selling Assets
May 18, 2011, 3:58 PM EDTBy Scott Lanman
(Updates with former official’s comment in 12th paragraph.)
May 18 (Bloomberg) -- Federal Reserve policy makers began to coalesce last month on a strategy to reverse record monetary stimulus by first ending their reinvestment policy and later raising interest rates and selling assets.
Almost all officials agreed that the “first step toward normalization” should be ceasing reinvestment of principal payments on mortgage debt that began in August, the Federal Open Market Committee said in records of its April 26-27 session, released today in Washington. A majority preferred to sell the Fed’s securities after raising short-term interest rates, and most wanted to put asset sales on a preannounced schedule while using federal-funds rate increases as an “active tool.”
The exit discussion was the most detailed since last June, before slumping growth pushed Fed Chairman Ben S. Bernanke and his colleagues to implement a $600 billion second round of bond purchases that ends next month. Crude-oil prices and financial- market inflation expectations have receded since the April FOMC meeting, reducing pressure on the Fed to exit.
The talks over the exit strategy don’t mean that tightening “would necessarily begin soon,” the report said. Policy makers agreed that the Fed’s securities portfolio, set to reach $2.6 trillion next month, would be shrunk “over the intermediate term” and return to “essentially only Treasury securities,” the minutes said.
The dollar reversed an earlier decline against the euro, while U.S. stocks remained higher and 10-year Treasury yields extended gains. The Standard & Poor’s 500 Index climbed 0.9 percent to 1,340.38 at 3:35 p.m., and the 10-year yield rose to 3.18 percent from 3.12 percent late yesterday.
First Press Conference
The minutes were the first to be released since Bernanke, 57, held his first regular press conference after the FOMC meeting ended April 27. The Fed released the quarterly economic projections of its governors and regional bank presidents the same day. The forecasts were previously disclosed with a three- week delay in the minutes.
Some of the 10 voting FOMC members said that “there would need to be a significant change in the economic outlook, or the risks to that outlook, before another program of asset purchases would be warranted.”
Another “few” members saw the “increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant the Committee taking steps toward less-accommodative policy sooner than currently anticipated,” the report said.
Removing Stimulus
At the previous FOMC meeting on March 15, policy makers differed over whether to begin removing stimulus this year, with a “few” taking the position on each side, minutes of the session showed.
Officials were most divided in April over how and in what sequence to use asset sales and interest rates to tighten credit. Many of the policy makers who wanted to put sales on a preannounced path said the pace should be gradual and could still be adjusted based on the economic outlook, while several preferred to use the pace as a “key policy tool” that could be “varied actively.”
A few policy makers said asset sales should precede any interest-rate increase, and a few others indicated both moves should “commence at the same time,” the minutes said.
“They are in no hurry to sell securities,” Vincent Reinhart, a former Fed monetary-affairs director who’s now a scholar at the American Enterprise Institute, said in a Bloomberg Radio interview. “They think they can tighten the stance of policy before they do that.”
Shrinking Balance Sheet
St. Louis Fed President James Bullard said any tightening campaign should begin with shrinking the Fed’s balance sheet, which could be done “passively” by not reinvesting maturing mortgage-backed securities or by actual sales.
“Whether you would supplement that with actual sales is controversial and undecided at this point,” Bullard said today in an interview before release of the minutes. Interest-rate changes would represent “bringing out the big guns” and likely come later, he said. Bullard indicated he would favor shrinking assets “a fair amount” before raising rates.
When officials met April 26-27, crude oil was trading close to its highest price since 2008. Inflation expectations, as measured by the breakeven rate for five-year Treasury Inflation Protected Securities, had climbed to 2.41 percentage points from 1.73 points at the end of 2010.
Inflation Expectations
Bernanke took several questions about inflation at his press conference, saying that “ultimately, if inflation persists or if inflation expectations begin to move, then there’s no substitute for action.” He indicated that he wasn’t concerned yet because “medium-term inflation expectations” had “not really moved very much.”
Since that briefing, the first of what will be four-times- a-year events, crude oil has dropped to $99.65 a barrel from $112.76, while the five-year TIPS breakeven rate has declined to 2.18 percentage points. Consumer gasoline prices haven’t had a similar drop yet, with the average retail cost per regular- unleaded gallon at $3.93 yesterday, compared with $3.89 on April 27.
The decline may help validate the FOMC’s judgment in the April statement that higher inflation from a rise in commodity prices earlier this year will be “transitory.” The Fed’s preferred price index, which excludes food and fuel costs, rose 0.9 percent in March from a year earlier, close to a five-decade low of 0.7 percent in December.
U.S. central bankers aim for an inflation rate of about 1.7 percent to 2 percent, based on last month’s long-run economic projections of Fed policy makers.
Growth Slowed
Fed policy makers projected last month that the economy will expand in a range of 3.1 percent to 3.3 percent this year, down from a 3.4 percent to 3.9 percent forecast in January. They gave that forecast the day before a report showed U.S. growth slowed to a 1.8 percent annual pace in the first quarter from 3.1 percent in the three months through December.
Fed staff economists cut their forecast for first-half U.S. growth on weaker spending while raising their near-term outlook for consumer prices, the minutes said. Staff forecasters expected inflation to recede “as food and energy prices were anticipated to decelerate,” the report said.
Growth was expected by the staff economists “to be sufficient to gradually reduce the unemployment rate over the projection period, though the jobless rate was anticipated to remain elevated at the end of 2012,” the minutes said.
--With assistance from Craig Torres in Washington. Editors: James Tyson, Christopher Wellisz
To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net
To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net
