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Fed takes baby step toward scaling back its bond purchases

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A number of Federal Reserve officials said at the central bank’s late April meeting that it could soon be time to begin talking about talking about scaling back its massive asset purchases, according to minutes of the discussion released Wednesday.

“A number of participants suggested that if the economy continued to
make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of
asset purchases,” the minutes said.

While not a major step, economists said it suggests the Fed may start to talk about when to make a plan in coming months.

“It was evidently a bit of a shot across the bow for the Treasury market. The passage came chock full of qualifiers…but it serves as notice that the FOMC will not sit still forever,” said Stephen Stanley, chief economist at Amherst Pierpont.

Since the Fed meeting, only one policy maker, Dallas Fed President Robert Kaplan, has said publicly he thought the economy would soon make enough progress to begin discussing pulling back its asset-purchase program.

In addition to holding benchmark rates at a range between 0% and 0.25%, the Fed is buying $80 billion of Treasurys and $40 billion of mortgage-backed securities each month to smooth financial market conditions and support the economy. The central bank has said it wants to see “substantial forward progress” before tapering these purchases. This is important because it would be the first step away from an easy-policy stance that supported financial markets during the height of pandemic-inspired instability back in March 2020.

Talk of a tapering has historically been a sensitive topic for investors since markets were roiled back in 2013, as then-Fed boss Ben Bernanke attempted to unwind the Fed’s accommodative asset purchases.

Back then, the suggestion of a reduction in bond purchases sent panic into global bond markets, and sent the 10-year yield rising around 1.40 percentage points in the span of four months, and Powell & Co. want to avoid a repeat of that episode.

Former New York Fed President William Dudley has said that the central bank can’t avoid upsetting the market entirely when it first signals a pullback.

According to the minutes, “various” Fed officials said it would likely be “some time” before the economy has met the “substantial further progress benchmark.”

“Many participants highlighted the importance of the committee clearly communicating its assessment of progress toward its longer-run goals well in advance of the time when it could be judged substantial enough to warrant a change in the pace of asset purchases,” the minutes said.

Last fall, the Fed adopted a new policy framework emphasizing that policy would be based on observed progress — and not forecasts of economic outcomes.

During the April meeting, “a couple of participants commented on the risks of inflation pressures building up to unwelcome levels before they become sufficiently evident to induce a policy reaction,” according to the minutes.

But the 11 voting members of the Fed’s interest-rate committee weren’t as concerned, minutes showed.

While these officials recognized “the expected rebound in spending as the economy continued to reopen was also likely to boost inflation temporarily, particularly
if supply bottlenecks limited how quickly production could respond to demand in the near term,” they also “viewed these increases in prices as likely to have only transitory effects on inflation.”

Since the meeting, there has been unexpectedly strong inflation data in April and a weaker-than-expected employment figures.

Michael Gapen, chief U.S. economist at Barclays, said because of the weak jobs data, “any discussion of tapering is at least two meetings out, if not more.”

Many other economists think Fed Chairman Jerome Powell may signal talk of tapering in late August during the Fed’s symposium in Jackson Hole, Wyo.

Economist and Fed adviser Diane Swonk tweeted that the minutes were the “beginning of the beginning” of tapering talk.

Financial markets have become volatile, with stocks
DJIA,
-0.48%

SPX,
-0.29%

sinking from recent record highs, reflecting increasing sensitivity to pricing pressures and the Fed’s potential reaction to rising inflation.

Market commentator Mohamed El-Erian has said investors are growing worried the Fed will be late to react to higher inflation. And former Treasury Secretary Larry Summers has forcefully argued the Fed needs to adjust policy to account for the risk that the economy could overheat.

On Wednesday, two Fed officials said they were not ignoring risks of an overheated economy and would be nimble about upcoming policy decisions.

The yield on the 10-year Treasury note
TMUBMUSD10Y,
1.675%

moved higher Wednesday after the minutes were released.

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