Fed Signals Pullback of Monetary Stimulus Likely to Start This Year

US Federal Reserve Board Chairman Jerome Powell arrives for the G20 finance ministers and central bankers meeting in Venice on July 9, 2021. (Photo by Andreas SOLARO / AFP) (Photo by ANDREAS SOLARO/AFP via Getty Images)
Photo by ANDREAS SOLARO/AFP via Getty Images

Federal Reserve officials last month made plans to begin scaling down the central bank’s bond purchases later this year, minutes from the Fed’s July meeting showed Wednesday.

The minutes, which summarize the meeting of the Federal Open Market Committee that took plans on July 27 and 28, indicate a growing consensus among Fed officials that the banks should begin to taper, or reduce, the $120 billion in monthly purchases of Treasury and mortgage bonds this year. There are three remaining meetings

Fed meeting, released Wednesday, shed light on an emerging consensus to begin scaling back their $120 billion in monthly purchases of Treasury and mortgage securities at any of their three remaining policy meetings this year, in September, November, and December.

“Most participants noted that, provided that the economy were to evolve broadly as they anticipated, they judged that it could be appropriate to start reducing the pace of asset purchases this year,” the minutes said.

If the Fed wants to give the market time to digest a plan to reduce purchases that would take place this year, it would likely need to do so in September. A later announcement would likely mean that the taper would not begin until 2022.

The minutes reveal that some officials argued that the Fed should wait until early next year. This would have the advantage of providing more information confirming the strengthening of the economy and labor market but would risk inflation becoming more persistent.

The meeting took place prior to a spate of weaker than expected economic data, including a severe drop in consumer sentiment and a larger than expected decline in homebuilder confidence. At the time of the meeting, the economic data was generally coming in stronger than expected.

“Participants observed that economic activity continued to expand at a rapid pace through the middle of the year even though capacity constraints were restraining the increase in output in some sectors,” the minutes said.  “Economic growth was expected to remain strong over the second half of the year, supported by the further reopening of the economy, accommodative financial conditions, and easing of supply constraints.”

If the economy continues to show signs of slowing by more than expected, Fed officials may reconsider the calendar for reducing bond purchases.

Fed officials expected a temporary rise in inflation as the economy reopened, fueled by accommodative monetary policy and several rounds of fiscal stimulus. But data over the past five months have shown that inflation has run hotter than expected and is broadening from the initial few categories where price hikes were first concentrated.

“Looking ahead, while participants generally expected inflation pressures to ease as the effect of these transitory factors dissipated, several participants remarked that larger-than-anticipated supply chain disruptions and increases in input costs could sustain upward pressure on prices into 2022,” the minutes said.

Fed officials also agreed on the importance of communicating to the market that reducing bond purchases will not automatically lead to a hike in the Fed’s interest rate target and the linked interest rate paid on reserves banks hold at the Fed.

“Many participants noted that, when a reduction in the pace of asset purchases became appropriate, it would be important that the Committee clearly reaffirm the absence of any mechanical link between the timing of tapering and that of an eventual increase in the target range for the federal funds rate,” the minutes said.

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