Until September of last year, the Federal Reserve structured each of its bond buying programs in the same way: it announced a fixed amount of purchases and a specific target end date. So, for example, in November 2010 it stated that it would purchase $600 billion of longer-term Treasury securities by the end of Q2 2011. This changed with the latest quantitative easing (QE) program launched last year. This time, instead of stating a specific dollar amount of purchases, Fed officials left the program open-ended: QE would continue as long as needed to ensure a stronger recovery in the labor market.
Under open-ended QE, what matters then is not the stated amount of Fed purchases, but rather market expectations for how long the flow of purchases will continue. The Fed could continue QE longer than the market expects, which should lead to lower interest rates, or cut the program off sooner than expected, which should cause interest rates to rise.
With the release of minutes from the March FOMC meeting this week, we see an increasingly wide gap between market expectations for QE and when Fed officials see the program wrapping up. According to the regular survey conducted by the Federal Reserve Bank of New York, market economists expect the current QE program to continue at the full amount of $85 billion per month through the end of this year, and also see a small amount of buying in the first quarter of 2014. Similarly, the latest forecaster survey by the Wall Street Journal shows that only one third of economists expect the Fed to slow the pace of buying before Q4 of this year, and nearly half (47%) do not expect the program to end before 2014. For most forecasters, open-ended QE means full speed ahead throughout 2013.
This contrasts with the views of most Fed officials. The minutes showed that only two voting FOMC members saw the program continuing at full-speed throughout this year. The majority opinion—which we think also reflects the views of Chairman Bernanke—was that QE would slow “later this year” and conclude “by year-end.” A few committee members also thought bond buying should slow this summer, and one advocated an immediate stop. We therefore think that most Fed officials see QE starting to wind down in the third quarter, and ending before 2014—earlier than expected by market economists.
We should be careful not to read too much into this. First, Fed officials are on average more optimistic about growth than private sector forecasters. The median forecast for 2013 gross domestic product (GDP) growth from private economists is currently 2.35% (on a Q4/Q4 basis).
In contrast, Fed officials expect GDP growth of 2.55% this year (mid-point of central tendency). Thus, at least some of the difference on QE could be chalked up to disagreement on the growth outlook. Second, the March FOMC meeting was before the very poor jobs report in April, and that may have moved Fed officials closer in line with the market consensus.
That being said, the minutes show that on the Fed’s forecast last month, QE would conclude this year. Although the latest jobs numbers have dampened optimism about U.S. growth, we doubt that one report significantly affected policymakers’ outlook. Indeed, San Francisco Fed President Williams reiterated his views on QE in a Wall Street Journal interview this week, saying it would be wrong to put much weight in a single data point. We therefore continue to see a risk that QE ends sooner than the consensus expects, which could help bond yields move higher later this year.
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