Hilsenrath Highlights The Fed's Taper Trilemma
While the issue of whether they will or won't taper is certainly still not clear, the WSJ's John Hilsenrath notes that the other dilemma facing the Fed is whether to reduce their purchases of Treasurys, mortgage-backed securities or both. According to officials, Hilsenrath notes, there were two lines of thinking at the Fed on how to structure a pullback from the bond programs and the issue would be discussed at the meeting. Goldman's Jan Hatzius has posited that "Fed leadership probably views MBS purchases as more effective in boosting economic activity than Treasury purchases," but as Hilsenrath notes, some Fed officials prefer a simpler-to-communicate strategy of proportional cutbacks to both MBS and Treasuries. The fact that Hilsy is reporting this suggests that a Taper is somewhat inevitable - as we have noted since the Fed remains cornered. On average, the market expects a $6bn taper on Treasuries and $3 billion for MBS
For some clarity on what the consensus thinks, here's Bloomberg: On average, the market expects a $6bn taper on Treasuries and $3 billion for MBS
Federal Reserve officials face a tough call when they gather today and Wednesday on whether to pull back on an $85 billion bond-buying program. And if they do decide to start winding down the program, they face a second tough call on whether to reduce their purchases of Treasurys, mortgage-backed securities or both.
Fed officials hadn’t settled on a strategy, according to interviews with officials and their public comments. Instead, there were two lines of thinking at the Fed on how to structure a pullback from the bond programs and the issue would be discussed at the meeting.
One line of thinking is that the Fed should pull back on Treasury purchases first, because mortgage bond purchases do more to boost the economy and thus should be left in place longer. According to this view, the Fed’s mortgage purchases work directly at holding down mortgage rates, and have had a more direct effect on the housing recovery than Treasury purchases, which hold down government borrowing costs but might not be feeding through to the broader economy.
This line of thinking is reinforced by the fact that mortgage rates have increased by more than a percentage point since May and officials would like to avoid as much as possible putting added upward pressure on them by reducing their purchases of mortgage bonds first.
The second line of thinking is that the Fed should keep its exit from its bond buying programs simple. According to this view, the Fed has struggled in the past few months to communicate a very complicated set of ideas about monetary policy to investors and its next steps should be as easy to explain as possible to avoid market confusion. So the Fed should reduce its purchases of Treasurys and mortgage-backed securities proportionately in the name of simplicity, this thinking goes.
This argument is made stronger, some officials believe, because research touting the superiority of mortgage purchases over Treasury purchases isn’t terribly convincing.
Of course there is a third line of argument too at the Fed. Among its policy hawks, none of these programs works very well and the Fed should end them all as soon as possible.
For most officials, though, it is a close call whether to pull back at this meeting.
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