By Nick Timiraos
(Dow Jones) — Federal Reserve officials are set to accelerate deliberations at their meeting next week over how to scale back their easy-money policies amid a stronger U.S. economic recovery than they anticipated six months ago.
Fed Chairman Jerome Powell has said their discussions are focusing on two important questions: When to start paring their monthly purchases of $80 billion in Treasury securities and $40 billion in mortgage securities, and how quickly to reduce, or taper, them.
The answers matter greatly to financial markets because Fed officials have said they aren’t likely to consider raising interest rates from near zero until they are done tapering the asset purchases.
Some officials have discussed concluding the purchases around October 2022 so they could lift rates later that year if the recovery is stronger or inflation is higher than now anticipated.
The Fed began buying large quantities of the securities in March 2020 when the Covid-19 pandemic triggered a near-meltdown in financial markets. The purchases aim to hold down long-term interest rates to encourage borrowing and spending.
Fed officials are likely to receive formal staff briefings at their meeting next week on potential strategies for tapering the bond purchases. No decisions have been made.
The timing of the Fed’s plans will depend on whether the economy keeps performing as expected and on whether Fed Chairman Jerome Powell can build a consensus among policy makers about how to proceed.
The Fed’s preferred inflation gauge, excluding volatile food and energy categories, rose 3.4% in May from a year earlier, a larger jump than officials had expected and more than their target of 2% on average. They said last August they would seek inflation moderately above that level for some time to make up for years of shortfalls.
While inflation is running well above that goal, Mr. Powell and many of his colleagues have said they still expect price increases to moderate as shortages driven by the reopening of the economy subside.
The central bank last December said it would continue the current pace of bond purchases until officials concluded they had achieved “substantial further progress” toward their goals of 2% inflation and robust employment.
“We have not achieved that,” New York Fed President John Williams said July 12.
Because Fed officials have said they would provide ample notice before they start tapering, they look unlikely to initiate any taper at their next two meetings, in July or September.
Instead, if they can agree on a plan this summer, they could provide updated guidance later this summer or at their September meeting on how soon actual reductions might begin. Mr. Powell could also use a speech at the central bank’s annual symposium in Jackson Hole, Wyo., in August to flesh out the latest thinking around emerging plans. That could tee the Fed up to start tapering around year’s end.
Mr. Powell faces more division among Fed officials over the outlook and the proper policy response than at any time since the pandemic forced the central bank to cut rates last year. At their June 15-16 policy meeting, 13 of 18 Fed officials projected they would raise rates by the end of 2023; seven expected to do so by the end of 2022.
One camp that thinks the Fed will need to raise rates sooner is angling to start the taper as soon as possible. There are good reasons to question “the story that inflation’s going to be temporary and it’s going to get back below the 2% inflation target, which…we won’t know until we get to next spring,” St. Louis Fed President James Bullard said last week. He said he wants to create flexibility “to handle the case where inflation does turn out to be more persistent.”
Another camp thinks recent price pressures will subside and could leave the Fed in the same position it faced for much of the past decade, in which global forces kept inflation below 2% even with historically low interest rates. “I’m still nervous that…it’s going to be tough to meet our inflation objectives,” Charles Evans, president of the Chicago Fed, said last week.
“I don’t worry so much about [tapering] one month early or two months early, or exactly what the pace is, but the overall interpretation of, ‘Is the Fed going to follow through and hit their long-run strategy objectives the way they told us,’ ” said Mr. Evans.
Officials are also weighing how quickly to taper the asset purchases. In 2013, the Fed ultimately shrunk its purchases in modest, equal amounts over the course of eight policy meetings, which spanned 10 months. Some officials have questioned whether they will be able to do that this time.
“I’m not sure that that’s necessarily the best approach this time because the economy is moving much faster here and the data…has a lot more variability than it did in that 2013-2014 period,” said Mr. Bullard.
Some officials are less concerned about falling behind the curve because they think the Fed has plenty of tools to tighten financial conditions, if needed; for example, Fed leaders could suggest a faster potential path of rate increases than currently anticipated.
“They can always say, ‘We’re going to taper soon, and faster than you thought, and we can raise rates sooner after that than you think,’ ” said William English, who was the senior Fed staff member responsible for overseeing the central bank’s tapering plans in 2013.
He expects the Fed will emphasize the potential to adjust the pace of purchases as they go. “Last time, everything went exactly as they’d thought, so they never made any adjustments,” said Mr. English, now a professor at the Yale School of Management. “That may not happen this time.”