QE-Unwind may start in September.
“We need to get on with this,” said Philadelphia Fed President Patrick Harker, a voting member of the policy-setting Federal Open Market Committee. He was talking about the Fed’s plan, detailed at the last meeting, to unwind QE. A possible moment to begin the process, he said, is the meeting in September.
His reasons: Complaints by his business contacts about rising wages.
Rising wages – regardless of what Fed Chair Yellen says publicly to soothe the nerves of the many underpaid workers – set off alarm bells at the Fed and push it into action. Not that all wages are rising. But average wages are rising faster than inflation, and in a number of sectors there are significant wage pressures. Businesses gripe. The Fed listens.
Harker told the Financial Times there was “very little slack” left in the labor market. “There is a rate [of unemployment] below which you are going to start to see a significant acceleration of wages.”
“You look at this labor market and you do have to question when we are going to start to see some increases in inflation,” he said. “We know from history that when that happens it happens pretty quickly.”
Hence, unwinding QE is on the table.
Bernanke explained in 2010 that QE was designed to create the “wealth effect,” where asset holders get wealthier (Part A) as asset prices are inflating, and thus they’d spend more and crank up the economy (Part B). Part A worked. Asset bubbles are now everywhere. Part B failed.
Now the question is when to reverse this wealth effect. There has apparently been unanimous agreement at the last meeting about the nuts and bolts of this plan. Initially, the Fed’s $4.5 trillion balance sheet will shed about $10 billion a month, which will rise over the next 12 months to $50 billion a month, and then continue at that level. This will amount to trimming the balance sheet by $600 billion a year.
The unwind could be launched “this year,” the FOMC statement said. Based on the FOMC meeting schedule, I mentioned at the time that this might happen “as soon as September.” Now Harker said it out loud.
The logic behind it? There will be four more FOMC meetings this year:
- July 25-26 (no presser)
- September 19-20 followed by Yellen’s press conference.
- October/November 31-1 (no presser)
- December 12-13 followed by Yellen’s press conference.
The Fed has been taking a policy action (raising rates) at every other meeting, starting in December, and only at meetings that were followed by press conferences. This is likely to continue. So no policy action at the July and October/November meetings.
Leaves the September and December meetings. The Fed penciled in one more rate hike this year and indicated that it would kick off the QE-unwind this year – two policy actions. And they’re not going to happen at the same meeting. So one likely in September, the other in December.
This assumes nothing untoward is happening before then, such as a sharp downdraft in the markets or a refusal by Congress to raise the debt ceiling. Harker warned about the latter and that it might impact the Fed’s decision because: “What we know from previous episodes of debt ceiling crises is they are not helpful to the economy.”
Harker laid out his idea of the schedule for policy action: Kick off the QE-unwind in September. “We need to get on with this,” he said. His business contacts were being “really pressured” by demands for higher wages, and he expected inflation to assert itself eventually.
“We have been talking about it for a long time; it has been part of our plan,” he told the Financial Times. “The economy is strong enough now where we can start to do what we have said we are going to do.”
He added, “if in fact inflation is softening then I would revise my stance of policy.” Yellen had taken pains after the last meeting to explain that this “softening” inflation – a godsend for consumers – has been due to “one-off” factors and would be temporary.
So, according to Harker’s ideas, QE-unwind might start in September followed “possibly” a rate hike in December. Despite four rate hikes in this cycle so far, monetary policy is still supporting the economy, he said.
He wants “to continue on this gradual path of removing accommodation,” he said. “Creating a soft landing is hard, but it is not impossible.”
But once asset bubbles have become so magnificent as our current set, a “soft landing” might be a pipe dream. The last two times when the Fed tightened its monetary policy after big asset bubbles had formed, it caused a dizzying stock market crash starting in 2000, which was practically benign compared to what came after the subsequent tightening cycle: the Financial Crisis. So the Fed will try to make sure that this time – to use the dreadful words – it’ll be different.
Oh my, how things have changed since late last year. Read… The Fed is on a Mission, Doesn’t Worry about Markets: New York Fed’s Dudley