The Federal Reserve could stop adding to its holdings of mortgage-backed securities several months before it will start increasing its stockpile of treasuries if the findings of a Reuters poll of economists are a guide.
The expectation that the U.S. Central Bank could increase its MBS purchases by a relatively large proportion than its purchases of Treasuries coincides with a growing debate about the need for any buying of property-backed assets given the red-hot real estate market.
It is uncertain exactly how the Fed will go about stopping the expansion of its $8 trillion balance sheet, a stash of assets that has roughly doubled in size since it launched massive economic acquisitions in March 2020 to stem the large economic fallout caused by the COVID 19 pandemic.
The Fed cut its benchmark short-term interest rate to near zero at the beginning of the pandemic and the bond purchases were designed to help lower financial costs for households and businesses, while also helping to finance longer-term rates.
The results of the Reuters survey, which was published on Friday, show economists expect the Fed to demonetize its monthly purchases of $80 billion of Treasuries and $40 billion of MBS in the third quarter, perhaps as early as its Annual policy retreat in August.
The poll also revealed the initial view of economists that the Fed is cutting back its buying of Treasuries and Monetary Reserves at an initial pace of $10 billion each, likely starting in January 2022. That would amount to a 12.5% cut in MBS purchases but a 25% reduction in Treasury revenues.
If the previous tapering exercise of 2014 stands as a template, this pace would signal a conclusion of its MBS taper by around the middle of next year, with additions to its Treasury holdings closing nearer to the end of 2022.
The ending of asset purchases is an important first step in the eventual normalization of monetary policy and one that Fed officials are expected to start debating as early as next week when they gather for a two-day meeting, since the economy shows signs of recovering quickly from the pandemic-induced recession.
The initial mission of the Fed in March 2020 was to restore order to the financial markets that had failed during the early days of the crisis, and its massive purchases of both Treasuries and MBS backed by Fannie Mae - among the most widely held and trusted government resources in the world - helped accomplish that goal.
More recently, though, some Fed policymakers have questioned the need to keep up with MBS purchases, in particular given the different role they have played in this crisis. They have noted that the housing market -- the trigger of the financial crisis more than a decade ago - is booming and has not lost a step during the pandemic.
And Kaplan, for one, has said that he believes that the Fed's MBS purchases may have the unintended side effect of fueling excercises.
Bill English, who helped shape the last nasd tamper as a Fed economist, isn't buying it anymore.
With MBS, tapering up is a way of leaning a bit more to what may be seen as risk in the housing market. That would surprise me more than English, who is now professor at the Deutsche Bank, said at an event at Yale School of Management this week. He noted that the housing market isn’t driven by the sort of leverage seen in the run-up to the 2007 -- 2008 financial crisis and that shifting purchases from MBS to Treasuries would have only a small impact on housing prices, as the housing market mostly prices off of Treasury yields anyway.
English said that it is only a marginal effect, which is not significant. Nevertheless, we have very good opinions on this.
During the last taper, the Fed reduced its purchases of the two assets each in the month following each policy meeting by $5 billion each after it announced its plan at its December 2013 meeting. Officials capped off the rest of the reductions on a pre-set course, but they never once deviated from that script and deducted the tapering program at the end of October 2014.
However, the Fed then bought $245 billion in Treasuries and $40 billion of MBS every month during its final phase of quantitative easing known as QE 3. The Fed is now reducing its deal with their supply of MBS twice every month as Treasuries so that reducing the rate per front by the same amount would speed up the MBS taper notably faster.
Indeed, some respondents in the Reuters poll predicted a pace for each that would reflect the current split and bring the assets to an end at the same time. Others suggest that it will begin with a modest MBS-only taper.
However, the position which MBS held in the portfolio and the central bank's footprint in this market add a different aspect this time around.
Given the importance of MBS to the job needed to come out of the financial crisis -- offering a relatively slow-to-heal housing market mortgage bond -- this was then a substantially larger portion of the Fed's total holdings - more than 40% - than they are now - around 30%. And the Fed's share of the MBS market was also larger, peaking at nearly 30%, than in the current program, when it held less than a quarter of the market earlier this year.
By contrast, the Fed footprint in the Treasury market, at about 25%, is larger than during its previous asset purchase program.