U.S. Federal Reserve Chairman Ben BernankeJonathan Ernst/Reuters
The U.S. Federal Reserve is eyeing the end of four years of extraordinary economic stimulus, with near unanimity from officials that the costs of intervening to drive down borrowing rates are starting to overtake the benefits.
Quantitative easing, or creating money to buy financial assets, could end "well before the end of 2013" because of concerns by several policy makers over financial stability, and that the Fed's portfolio of assets – now over $2-trillion (U.S.) – is becoming too large, according to minutes of the central bank's December policy meeting, released in Washington after the customary three-week delay.
Bond yields jumped and equities fell as some investors braced for a earlier-than-expected reduction in monetary stimulus. The minutes said "almost all" members of the policy committee were wary that the benefits of ongoing asset purchases no longer outweigh the potential costs, suggesting the Fed will reverse course on QE at the earliest opportunity.
The Fed's commitment to QE currently is open-ended, causing some market participants to characterize the Fed as on cruise control – at a speed in excess of posted limits. The minutes alter that impression, describing instead a central bank that is growing wary of its real-life experiments in monetary policy.
"This further supports our contention that many members are growing increasingly uneasy as the Fed proceeds through uncharted territory with a continuation of long term unconventional monetary policy," Adrian Miller, director of fixed income strategy at GMP Securities in New York, advised clients in a note Thursday.
The possibility of the end of quantitative easing comes even as the U.S. government begins to withdraw fiscal stimulus, with payroll, income and other taxes on the rise.
At issue is the efficacy of quantitative easing, or QE, the largely untested policy that the Fed has used to fight the financial crisis since dropping its benchmark interest rate to zero at the end of 2008. QE stokes economic growth by keeping downward pressure on borrowing rates.
Now in the middle of its third such program, the Fed has purchased more than $2-trillion of Treasuries and securities backed by government-guaranteed mortgages. Despite the widespread reservations, the Federal Open Market Committee in December opted to continue purchasing longer-dated Treasuries and mortgage-backed securities at a pace of $85-billion a month until it detects a meaningful improvement in the outlook for employment.
The Dec. 11-12 meeting of the Fed's policy committee was a significant one. Chairman Ben Bernanke won a consensus on tying the eventual increase in the benchmark rate to numeric targets, an exercise in transparency that never before had been tried. The minutes show there was surprisingly little dissent over the decision to replace a conditional pledge to keep the rate at zero until at least the middle of 2015 with a pledge to do so until the unemployment rate drops to 6.5 per cent, so long as inflation stays below 2.5 per cent.
The policy committee also opted to end "Operation Twist" – the policy of selling shorter-term debt from the Fed's holdings to buy longer-dated Treasuries – and simply create the money to buy the bonds, expanding its existing quantitative easing program. The Fed now is buying $45-billion of Treasuries a month, and $40-billion of mortgage-backed securities.
Those purchases aren't about to come to an abrupt end.
Mr. Bernanke will keep interest rates low until the threat from fiscal uncertainty passes. The "fiscal cliff" was a significant worry of policy makers in December, and this week's resolution only was a partial one. Left undecided was what to do about the $100-billion of across-the-board spending cuts, and the Treasury says it will run out of accounting tricks to stay below its borrowing limit within a couple of months.
But once the headwinds recede, it's an open question when he and other policy makers will seek to end quantitative easing.
Despite the widespread anxiety about the financial risks associated with more bond buying, a "few" members think the Fed would need to keep buying bonds until the end of the year, and a "few" others underlined the need for "considerable policy accommodation" without providing a timeline for purchases.