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FOMC minutes

FOMC participants remain cautiously optimistic on QE3 tapering

When should the wind down begin?

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Nearly all Federal Open Market Committee members confirmed they are ‘broadly comfortable’ with the timeline Federal Reserve chairman Ben Bernanke put into action for tapering its bond-buying program later this year if the economy continues to improve, according to minutes of the latest meeting.

Nonetheless, there was still division on when the appropriate time to begin winding down the central bank’s open-ended third round of quantitative easing would be – with a few urging patience in the economic recovery and others favoring tapering its asset purchases.

"While a range of views were expressed regarding the cumulative improvement in the labor market since last fall, almost all committee members agreed that a change in the purchase program was not yet appropriate," the minutes revealed.

Federal Reserve Bank of Kansas City president Esther George was the only dissenting member of the FOMC’s action, explaining that she favored including in the policy statement a more explicit signal that the pace of the current asset purchases would be reduced in the near term.

Overall, the FOMC minutes were largely in line with the market's expectation that the central bank would begin wind down QE by the fall, explained Zillow Mortgage Marketplace director Erin Lantz.

"The minutes did not provide much insight to the Fed's thinking beyond what already had been discussed," Lantz said. 

She continued to say that she expects the Fed "would begin scaling backs its stimulus program in September, provided upcoming data continues to indicated a sustained economic recovery."

The FOMC also discussed the potential for establishing a “fixed-rate, full-allotment overnight reverse purchase agreement facility” as an additional tool to help keep short-term interest rates at targeted levels when the Fed decides to reduce its monetary policy.

The facility would allow the committee to offer overnight, risk-free instruments to a wide range of market participants, perhaps complementing the payment of interest on excess reserves held by banks — improving the FOMC’s ability to keep rates at levels deemed appropriate to achieve its economic goals.

"In general, meeting participants indicated that they thought such a facility could prove helpful; they asked the staff to undertake further work to examine how it might operate and how it might affect short-term funding markets," according to the minutes.

In general, if economic conditions improve as expected, the committee would moderate the pace of its securities purchases later this year and the members would also reduce the pace of purchases in measured steps, concluding the purchase program around the middle of 2014.

However, Amherst Securities Group senior managing director Laurie Goodman said if the Fed fails to taper by the fourth quarter of 2013, the central bank will be absorbing 75% of gross deliverable agency supply. If the Fed wants to hold purchases at the same percent of supply as it current does, it must cut new purchases by 40%.

"We don't believe the market is adequately building this in, which suggests to us that investors should maintain a positive bias on the mortgage basis, and any substantive weakness resulting from talks of tapering should be viewed as a buying opportunity," Goodman explained.

Furthermore, participants considered whether it would be appropriate to include in the committee’s policy statement additional information about the members outlook on continued bond purchases.

While most members thought additional information on when the central bank would begin tapering its asset purchases, there was a clear division on how to successfully convey the message without raising uncertainty again.

"Several participants favored including such additional information in the policy statement to be released following the current meeting; several others indicated that providing such information would be most useful when the time came for the Committee to begin reducing the pace of its securities purchases, reasoning that earlier inclusion might trigger an unintended tightening of financial conditions," the minutes noted.

The potential for strengthening the committee’s forward guidance for the federal funds was also discussed.

Overall, there was support for maintaining the current thresholds in the forward guidance.

However, several participants were willing to consider lowering the unemployment threshold if additional accommodation were to become necessary or if the committee wanted to adjust the mix of policy tools used to provide the necessary level of accommodation. No specific numerical thresholds were indicated.

We don’t believe the market is adequately building this in, which suggests to us that investors should maintain a positive bias on the mortgage basis, and any substantive weakness resulting from talks of tapering should be viewed as a buying opportunity. 

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