By Steven K. Beckner
(MNI) – Although Federal Reserve policymakers opted to reinvest
proceeds of maturing mortgage backed securities in longer term
Treasuries, they were prepared to reinvest them in new MBS, minutes of
the Fed’s mid-August Federal Open Market Committee meeting showed
Tuesday.
The Fed has a statutory mandate to promote both maximum economic
growth and price stability, and the minutes show that Fed officials were
increasingly concerned on both scores at the Aug. 10 FOMC meeting.
The minutes show greater worry about the outlook for growth and
price stability among Fed policymakers and their staff advisors.
Not that they feared higher inflation. Far from it. The predominant
view was that slower-than-expected growth and job creation might cause
prices to rise too slowly.
The members did not put high odds on outright deflation, but they
elevated the risks of excessive disinflation even as they reduced their
growth expectations.
The committee was also confronted with a shrinkage of its balance
sheet due to heavy mortgage refinancings and prepyaments. Fearing this
would cause an inadvertent tightening of monetary policy, officials
acted to halt the shrinkage. And minutes show a readiness to consider
new stimulus measures.
As previously reported, on Aug. 10, the FOMC voted to reinvest the
proceeds of maturing mortgage backed securities in Treasury securities
to prevent any such shrinkage.
“To help support the economic recovery in a context of price
stability, the Committee will keep constant the Federal Reserve’s
holdings of securities at their current level by reinvesting principal
payments from agency debt and agency mortgage-backed securities in
longer-term Treasury securities,” the Fed said in its policy
announcement.
After the FOMC announcement was released, the New York Federal
Reserve Bank declared that its open market trading desk would seek to
maintain the value of outright holdings of domestic sedcurities at
around $2.054 trillion — the amount held as of Aug. 4.
Explaining its decision, the FOMC said “the pace of recovery in
output and employment has slowed in recent months.”
Before their policy discussion, the minutes reveal, the FOMC
received a staff report estimating that repayments of principal on
agency MBS would likely shrink the value of those holdings by $340
billion from August 2010 through the end of 2011 — and could fall even
more if mortgage rates were to decline further.
What amounted to a quantitative de-easing concerned the committee
in the light of recent slowing of the economy.
The FOMC was not due to make a new quarterly forecast, but minutes
show that the Fed staff “lowered its projection for the increase in real
economic activity during the second half of 2010 but continued to
anticipate a moderate strengthening of the expansion in 2011.”
“Over the forecast period, the increase in real GDP was projected
to be sufficient to slowly reduce economic slack, although resource
slack was still anticipated to remain quite elevated at the end of
2011.”
The staff was also concerned about further disinflationary
tendencies. “The wide margin of economic slack was projected to
contribute to some slowing in core inflation in 2011, though the extent
of that slowing would be tempered by stable inflation expectations,” say
the minutes.
FOMC “participants” more generally reflected these staff concerns,
anticipating “more modest growth in the near term,” although they
“continued to anticipate that growth would pick up in 2011.”
Minutes show that the FOMC was “unclear” about what the increase in
personal savings meant for household spending. There was also concern
about the pace of business spending, which was seen slowing from a quick
pace that had been caused by an unsustainable replacement of equipment
and software that had been postponed during the recession.
A big issue for both business hiring and business investment, as
far as a number of Fed officials were concerned, was “uncertainty about
the fiscal and regulatory environment made them reluctant to expand
capacity” — something that various policymakers have publicly cited
before and since.
Still another concern was that credit conditions, while improved,
were still tight, especially for small firms.
All of these and other factors left the FOMC leery of the outlook
and of the shrinkage of the Fed balance sheet.
“Weighing the available information, participants again expected
the recovery to continue and to gather strength in 2011,” say the
minutes. “Nonetheless, most saw the incoming data as indicating that the
economy was operating farther below its potential than they had thought,
that the pace of recovery had slowed in recent months, and that growth
would be more modest during the second half of 2010 than they had
anticipated at the time of the Committee’s June meeting….”
“Many policymakers judged that downside risks to the U.S. recovery
had become somewhat larger; a few saw the incoming data as suggesting a
greater risk that private demand for goods and services might not grow
enough to offset waning fiscal stimulus and a smaller impetus from
inventory restocking….”
Nor were FOMC participants entirely comfortable with the inflation
outlook.
“Many said they expected underlying inflation to stay, for some
time, below levels they judged most consistent with the dual mandate to
promote maximum employment and price stability,” say the minutes.
“Participants viewed the risk of deflation as quite small, but a number
judged that the risk of further disinflation had increased somewhat
despite the stability of longer-run inflation expectations.”
Agreeing that the federal funds rate needed to stay near zero,
“members still saw the economic expansion continuing, and most believed
that inflation was likely to stabilize near recent low readings in
coming quarters and then gradually rise toward levels they consider more
consistent with the Committee’s dual mandate for maximum employment and
price stability.”
“Nonetheless, members generally judged that the economic outlook
had softened somewhat more than they had anticipated, particularly for
the near term, and some saw increased downside risks to the outlook for
both growth and inflation,” the minutes say.
“Some members expressed a concern that in this context any further
adverse shocks could have disproportionate effects, resulting in a
significant slowing in growth going forward,” they go on. “While no
member saw an appreciable risk of deflation, some judged that the risk
of further near-term disinflation had increased somewhat.”
“More broadly, members generally saw both employment and inflation
as likely to fall short of levels consistent with the dual mandate for
longer than had been anticipated,” the minutes add.
Against that backdrop, the FOMC “discussed the implications for
financial conditions and the economic outlook of continuing its policy
of not reinvesting principal repayments received on MBS or maturing
agency debt.”
“The decline in mortgage rates since spring was generating
increased mortgage refinancing activity that would accelerate repayments
of principal on MBS held in the SOMA,” the minutes explain. “Private
investors would have to hold more longer-term securities as the Federal
Reserve’s holdings ran off, making longer-term interest rates somewhat
higher than they would be otherwise.”
The minutes say “most members thought that the resulting tightening
of financial conditions would be inappropriate, given the economic
outlook.”
But “members noted that the magnitude of the tightening was
uncertain, and a few thought that the economic effects of reinvesting
principal from agency debt and MBS likely would be quite small.”
But most members “judged, in light of current conditions in the MBS
market and the Committee’s desire to normalize the composition of the
Federal Reserve’s portfolio, that it would be better to reinvest in
longerterm Treasury securities than in MBS.”
But the FOMC left the door open to other uses for the MBS proceeds.
“While reinvesting in Treasury securities was seen as preferable given
current market conditions, reinvesting in MBS might become desirable if
conditions were to change.”
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