The Fed, a Decade After the Crisis, Is About to Embark on the Great Unwinding
After a historic buildup of its bond portfolio to support the U.S. economy, the central bank plans to shrink its holdings, entering uncharted territory
By Nick Timiraos
WASHINGTON—The Federal Reserve resorted to a series of shock-and-awe stimulus campaigns to stabilize the economy after the financial crisis. Now the Fed is preparing the final move to unwind its support—and it wants to be as boring as possible.
The central bank is likely to announce Wednesday it will start slowly shrinking its $4.2 trillion portfolio of mortgage and Treasury bonds purchased during and after the financial crisis. It will do so passively by allowing some bonds to mature without replacing them.
The markets haven’t blinked at Fed signals for many months that this moment was nearing.
But plenty could still go wrong. The central bank has never before had such a large balance sheet or attempted to do this.
If it succeeds, the central bank will quietly close a chapter on an extraordinary policy experiment that lowered borrowing costs for homeowners, businesses and consumers, and will provide a model for other central banks that followed suit. A misstep could disrupt growth at a time when major economies are finally expanding in sync.
Chairwoman Janet Yellen’s management of the process will shape the final verdict on whether the bond-buying was successful, which in turn could determine whether it remains a policy tool for future downturns.
“She has reached agreement in a way that is really impressive. Markets didn’t freak out.
Nobody said ‘boo,’ ” said Austan Goolsbee, who headed the White House Council of Economic Advisers in 2010-2011. Now, he said, “The final exam, with the grade yet to be determined, is can the Fed actually get out of this stuff.”
Other central banks that adopted such programs are watching, particularly the European Central Bank, which is considering whether to wind down its asset purchases next year.
When central bankers began these unconventional campaigns, “we had no idea what we should buy, how much, for how long,” said David Blanchflower, a Dartmouth economist who was on the Bank of England’s monetary policy committee from 2006 to 2009. Similarly, “there is no idea on the way going out.”
Markets’ ho-hum reaction so far prompted J.P. Morgan Chase & Co.’s James Dimon to warn this summer against complacency. The Fed’s unwind “could be a little more disruptive than people think,” the CEO said at a conference in Paris. With other central banks set to pull back on stimulus, “the tide is going out.”
Added Matthew Jozoff, J.P. Morgan’s mortgage-debt strategist: “We have never seen a central bank exit out of $1 trillion of mortgage-backed securities, so we are concerned about how this is going to go.”
What could go wrong is hard to predict. When the Fed discussed plans to pare its purchases of new bonds in 2013, a tumble in prices sent yields soaring, in what was called the taper tantrum.
The unanticipated turmoil included capital outflows from emerging markets. Fed officials’ desire to avoid a replay has driven careful planning for the balance-sheet wind-down, according to current and former Fed officials.
The Fed launched its bond buying in late 2008, at the depth of the financial crisis, to shore up money-market funds, companies and banks.
A government takeover of housing-finance giants Fannie Mae and Freddie Mac had failed to thaw the mortgage market. So the Fed began buying hundreds of billions of dollars of their debt and mortgage-backed securities to get mortgage rates down. Rates fall as bond prices rise.
“Imagine in your neighborhood no one is buying houses, and all of sudden someone buys 50% of the houses for sale. That is going to stabilize prices,” said David Spector, chief executive of mortgage originator PennyMac Financial Services Inc.
The Fed later decided it needed to do more to support the economic recovery, and over the next three years it launched two other bond-buying rounds to lower long-term interest rates and keep inflation from going below zero.
.
Buying long-term bonds sends some investors into riskier assets, buoying stocks, corporate bonds and real estate. Ultralow interest rates allowed millions of Americans to refinance, reducing foreclosures and freeing up cash for spending.
“They saw an effect similar to a tax cut,” said Mr. Spector of PennyMac.
Problems some critics warned about, such as roaring inflation and currency debasement, haven’t materialized. Labor markets have tightened, dropping unemployment to a 16-year low in July, while price pressures have been muted.
At the same time, the bond-buying has fueled concerns about frothy asset values, such as in commercial real estate. And while financial markets have boomed, economic growth and business investment have been unspectacular
Research published by the Fed in April estimated its purchases have reduced by around 1 percentage point what economists call a “term premium,” the extra yield investors demand for the risk of lending over a longer term.
Fed economists estimated this stimulus would decline slightly this year as markets anticipate the end of bond reinvestments. When the Fed’s balance sheet returns to a more normal level, the term premium could still be around 0.25 percentage point lower than if the bond programs had never occurred.
The Fed, though it stopped adding to its holdings of bonds in 2014, has continued to reinvest the proceeds of those that mature. It owns $1.7 trillion in mortgage bonds issued by government-related entities, or around 29% of the market, and around $2.4 trillion in Treasurys, which is 17% of that market.
In June, the Fed said when it started to shrink its balance sheet it would do so by allowing a small initial amount of bonds—$4 billion of mortgages and $6 billion in Treasurys per month—to run off the portfolio without reinvestment. Every quarter, it will let a slightly larger amount do so, up to a maximum of $20 billion in mortgages and $30 billion in Treasurys per month.
For the next year or so, the Fed should still end up buying bonds in most months, since only a small fraction will mature and go not replaced, said Richard Clarida, an economist at Pacific Investment Management Co., or Pimco. He compared the start of the plan to losing weight by eating only two desserts a day instead of three.
One question the central bank hasn’t yet decided: How large should its balance sheet be at the end of the process?
Its holdings have swelled to $4.5 trillion from less than $900 billion before 2008. Though they will fall, the Fed will end up with more assets than it had before the crisis because its liabilities have grown—there’s more currency in circulation. The balance sheet size could settle out at between $2.4 trillion and $3.5 trillion sometime early next decade, New York Fed President William Dudley said in a speech earlier this month.
That would mean the Fed would end up selling only around $1 trillion to $2 trillion in securities after having added $3.7 trillion between 2008 and 2014.
One reason markets have been relatively unfazed is that central banks in Europe and Japan are still purchasing assets. Mr. Spector of PennyMac expects the start of the Fed’s unwinding to have little effect on mortgage rates, which in early September hit their lowest levels of the year.
BALANCING ACT
Expansionary monetary policy in Europe and Japan could postpone or defer any volatility from the wind-down of the Fed´s balance sheet. Percentage change since 2003 in the balance sheets of major central Banks.
The Fed wants to move now because the economy is on stronger footing. Its large holdings have become a political liability, with critics saying the mortgage-debt buying, in particular, exceeded the Fed’s mandate once normal market functioning had been restored.
Central bankers are “comfortable with the extraordinary actions they took during the crisis, and they know not everybody is,” said Lou Crandall, chief economist at financial research firm Wrightson ICAP. “If the unwind is successful, it will bolster the case for” similar bond buying in the future.
Hanging over the discussions has been the question of who will lead the Fed next year. Ms. Yellen’s term expires in February, and Vice Chairman Stanley Fischer is giving up his seat.
There are three other vacancies on the seven-seat board of governors.
By reaching unanimous agreement on the balance-sheet plan this year, the Fed has essentially resolved the issue for any Yellen successor and given more certainty to markets, just as Ben Bernanke in 2013 announced plans to gradually reduce the Fed’s purchases before his term as chairman ended in 2014.
The balance-sheet plan bears hallmarks of Ms. Yellen’s meticulous, leave-nothing-to-chance leadership, say current and former Fed officials. The core of it came together three years ago.
Officials said they would raise the federal-funds rate before starting on the balance sheet, and wouldn’t be bond sellers.
..
The rate-setting committee ramped up discussions at its March 2017 meeting, weighing questions such as whether to set a fixed calendar or to condition a wind-down on economic conditions; the pros and cons of a phasing out of reinvestments vs. stopping cold turkey; and whether to treat mortgage bonds and Treasurys differently.
After the March discussion, a majority—around 10 of the committee’s 17 members—appeared to form a consensus: The Fed’s plans should be predictable and passive. Tapering the pace of bond reinvestments would extend the process by a year, reducing the chance of spike in bond yields.
It should be as exciting as watching paint dry, Philadelphia Fed President Patrick Harker later said.
In regular calls and meetings to gain more feedback from committee members after the March meeting, Ms. Yellen gently highlighted the growing consensus to those who had different ideas.
Meantime, when minutes of the meeting revealed details of the discussion, markets shrugged, helping to move off the fence some who worried about acting too soon. By the Fed’s June meeting, officials who were uneasy about moving ahead with rate increases voiced little concern about starting the balance-sheet plan, largely because it was so gradual.
“We won’t know until we actually take the action, but I’m reasonably confident that it’s not likely to be much of an event,” said Boston Fed President Eric Rosengren. “We communicated it better this time.”
0 comments:
Publicar un comentario