–Most Want to Sell Agencies, MBS After 1st FFR Hike
–Most Want to Postpone Asset Sales Til Recovery Well Established

By Steven K. Beckner

(MNI) – Although Federal Reserve officials modestly upgraded their
forecast for growth and jobs in late April, they were no more inclined
either to raise interest rates or shrink the Fed’s bloated balance sheet
in the face of continued high unemployment and “subdued” inflation,
minutes of the Fed’s April 27-28 Federal Open Market Committee meeting
showed Wednesday.

FOMC members discussed options for managing the balance sheet with
the Fed staff, and the minutes show that, while there was a consensus
for “eventually” selling agency debt and agency-guaranteed mortgage
backed securities, few were prepared to move forward with such sales
soon.

Most wanted to delay asset sales until after the first federal
funds rate hike, which the FOMC agreed would come only after “an
extended period” near zero. And even then, most wanted to sell agencies
and agency MBS only “gradually” after plenty of advance warning.

Federal Reserve governors and presidents revised their quarterly,
three-year forecast to project somewhat faster growth than they had in
January.

They now expect GDP to grow by a real 3.2% to 3.7% this year — up
from 2.8% to 3.5% in the January forecast. They expect real GDP growth
of 3.4% to 4.5% next year and 3.5% to 4.5% in 2012. The “longer run”
growth projection was unchanged at 2.5% to 2.8%.

They expect the unemployment rate to end the year between 9.1% and
9.5 percent — down from January’s 9.5% to 9.7% forecast and down from
the current 9.9%. The project unemployment between 8.1% and 8.5% next
year; 6.6% to 7.5% in 2012.

The “longer run” unemployment projection, which might be taken as a
proxy for the FOMC’s assumption on the “natural” or “non-accelerating
inflation rate of unemployment” (NAIRU) is 5.0% to 5.3%. That is up only
slightly from January’s 5.0% to 5.2%. Some Fed officials believe NAIRU
has risen to as high as 7%.

On inflation, the FOMC “central tendency” forecast is that the
price index for personal consumption expenditures (PCE) will rise 1.2%
to 1.5% this year — down from 1.4% to 1.7% in January. It is projected
at 1.1% to 1.9% in 2011 and 1.2% to 2.0% in 2012.

The “longer run” inflation projection, which is regarded as the
equivalent of an implicit inflation target, was left unchanged at 1.7%
to 2.0%.

The core PCE is expected to rise 0.9% to 1.2% this year — down
from 1.1% to 1.7% in January. It is expected to edge up to between 1.0%
and 1.5% next year and 1.2% to 1.6% in 2012.

The FOMC’s forecast summary calls the policymakers’ forecasts
“broadly similar to their previous projections” and remarks that they
are “subject to greater-than-average uncertainty.”

The actual minutes’ report on policy deliberations contain no real
surprises. They largely reflect the slightly more upbeat policy
statement issued on April 28, in which the FOMC reaffirmed that the
funds rate would be kept “exceptionally low … for an extended period”
so long as certain conditions continue to prevail, namely “low rates of
resource utilization, subdued inflation trends, and stable inflation
expectations.”

Policymakers “agreed that no changes to the Committee’s federal
funds rate target range were warranted at this meeting” because “on
balance, the economic outlook had changed little since the March
meeting,” say the minutes.

“Even though the recovery appeared to be continuing and was
expected to strengthen gradually over time, most members projected that
economic slack would continue to be quite elevated for some time, with
inflation remaining below rates that would be consistent in the longer
run with the Federal Reserve’s dual objectives,” the minutes continue.

The minutes disclose that “a few members noted that at the current
juncture, the risks of an early start to policy tightening exceeded
those associated with a later start, because the scope for more
accommodative policy was limited by the effective lower bound on the
federal funds rate, while the Committee could be flexible in adjusting
the magnitude and pace of tightening in response to evolving economic
circumstances.”

Officials differed on the outlook for inflation: “Some participants
saw the risks to inflation as tilted to the downside in the near term,
reflecting the quite elevated level of economic slack and the
possibility that inflation expectations could begin to decline in
response to the low level of actual inflation.”

“Others, however, saw the balance of risks as pointing to
potentially higher inflation and cited pressures on commodity and energy
prices associated with expanding global economic activity as an upside
inflation risk; some also noted the possibility that inflation
expectations could rise as a result of the public’s concerns about the
extraordinary size of the Federal Reserve’s balance sheet in a period of
very large federal budget deficits.”

But all agreed it was “important for policy to be responsive to
changes in the economic outlook and for the Federal Reserve to continue
to communicate clearly its ability and intent to begin withdrawing
monetary policy accommodation at the appropriate time and pace.”

Of greater interest is what the minutes reveal about FOMC members’
views on asset sales, although there too there were no great surprises
for MNI readers. MNI has reported for months that most Fed officials
support selling agencies and agency MBS only later in the tightening
process and that those sales would likely be gradual and pre-announced.

The minutes confirm that to be the majority view during a debate
that ensued after the Fed staff presented “potential longer-run
strategies” and “discussed the potential portfolio paths and
macroeconomic consequences of a number of different strategies” for
returning to an all-Treasury portfolio.

There were broad areas of consensus: “Meeting participants agreed
broadly on key objectives of a longer-run strategy for asset sales and
redemptions. The strategy should be consistent with the achievement of
the Committees objectives of maximum employment and price stability.”

“In addition, the strategy should normalize the size and
composition of the balance sheet over time,” the minutes continue.
“Reducing the size of the balance sheet would decrease the associated
reserve balances to amounts consistent with more normal operations of
money markets and monetary policy.”

“Returning the portfolio to its historical composition of
essentially all Treasury securities would minimize the extent to which
the Federal Reserve portfolio might be affecting the allocation of
credit among private borrowers and sectors of the economy,” they add.

There was also a consensus, if not unanimity, on the proposition
that the Fed could not just let maturing securities run off to shrink
the balance sheet: “Most participants expressed a preference for
strategies that would eventually entail sales of agency debt and MBS in
order to return the size and composition of the Federal Reserve’s
balance sheet to a more normal configuration more quickly than would be
accomplished by simply letting MBS and agency securities run off.”

There was broad agreement that, whenever the time comes, “sales of
agency debt and MBS should be implemented in accordance with a framework
communicated in advance and be conducted at a gradual pace that
potentially could be adjusted in response to changes in economic and
financial conditions.”

However, FOMC members parted ways when it came to how soon and how
much assets should be sold. “Participants expressed a range of views on
some of the details of a strategy for asset sales.”

But, as MNI has been reporting, “most participants favored
deferring asset sales for some time.”

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