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Why Fisher says Fed asset purchases are still too substantial

Phalguni Soni

Richard Fisher on monetary policy: Where to from here? (Part 5 of 9)

(Continued from Part 4)

The Dallas Fed’s Richard Fisher at the Asia Society

Fisher spoke at the Asia Society in Hong Kong on Friday, April 4, about “forward guidance” in monetary policy, which he described as “the subject du jour of central bankers.” It recently became a focus of discussion again in the U.S. after the Fed’s March FOMC meeting, when the Fed decided to go with “qualitative” rather than “quantitative” guidance regarding its future monetary policy statements. During his address, Fisher also spoke about using the existing pool of liquidity that quantitative easing (or QE) had created (for a detailed explanation, please refer to Part 2 of this series).

Richard Fisher’s take on capital expansion and reducing labor market “slack”

Fisher said, “It’s clear to me that we have a liquidity pool that is more than sufficiently deep and wide enough nationwide to finance job-creating capital expansion and reduce labor market ‘slack.’ But that will happen only if and when our fiscal authorities—the Congress and the president—are able to muster the courage to craft tax, spending and regulatory incentives for job-creating enterprises to mobilize liquidity for expansion and payroll growth.”

For more of Richard Fisher’s views on creating velocity using excess reserves, please see the Market Realist series Richard Fisher explains why excess reserves can create velocity.

Inflation, the invisible elephant

With inflation and inflation expectations remaining benign and far short of the Fed’s target long-term rate of 2%, injecting “massive” amounts of liquidity into the monetary base would compound the Fed’s future problems. The Fed would have to deal with giant sums of high-powered money, which could prove inflationary in the long run and even surpass the Fed’s long-term inflation goal of 2%.

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To learn more about firms and their inflation expectations, read the Market Realist series A guide to the Atlanta Fed Business Inflation Expectations Survey.

Declines in the supply of mortgage-backed securities (or MBS) are outpacing the taper

The Fed has announced a reduction in its monthly bond buying program of longer-term Treasuries (TLT) and agency-backed mortgage securities (MBB) by $10 billion at each of its last three meetings, to $55 billion per month at present. At the current pace, monthly asset purchases will end in October. Fisher finds even $55 billion per month in bond purchases excessive.

Fisher feels that Fed purchases of MBS (VMBS) are outpacing their issuance. Already, the Fed purchases ~85% of new issuance in MBS (MBB). By the end of QE3 (the taper is projected to end by October 2014 at the current pace), the Fed would hold about 40% of the total MBS (VMBS) market and ~25% of the total outstanding Treasuries (TLT). Once tapering concludes, the Fed is expected to once again manage monetary policy by modifications in the base rate.

The iShares 20+ Year Treasury Bond (TLT) provides exposure to long-term Treasury securities. Both the Vanguard Mortgage-Backed Securities Index Fund (VMBS) and the iShares Barclays MBS Fixed-Rate Bond Fund (MBB) track the Barclays Capital U.S. MBS Index, which measures the performance of the investment-grade fixed-rate mortgage-backed pass-through securities of GNMA, FNMA, and FHLMC.

To find out more about the form of forward guidance Fisher advocates for, please read on to Part 6 of this series.

Continue to Part 6

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