If Federal Reserve policy makers had a motto, it would be "better safe than sorry."
Data in the six weeks since the Fed's last policy meeting paint a picture of an improving U.S. economy with rebounds in retail sales, manufacturing activity and private-sector hiring. Officials on Wednesday are expected to upgrade their assessment of the economy, but with unemployment near 10% and inflation rates still low, that is as far as they are likely to go.
Still, it is a step in the process, if a glacial one, toward a reversal of the Fed's ultraloose monetary policy via near-zero interest rates. Already, the central bank has closed nearly all its temporary lending programs and ended purchases of $1.25 trillion of mortgage-backed securities.
So far, that has caused little market disruption. As of Monday, 30-year mortgage rates stood just 0.63 percentage points above 10-year Treasury notes, according to Barclays Capital, compared with 0.65 percentage points in January.
Maintaining that calm, however, depends critically on the Fed's next moves. Investors have become jittery the Fed will start dumping its mortgage assets into the market.
Worry grew after Fed Chairman Ben Bernanke in March said the Fed "has the option of redeeming or selling securities," while Minneapolis Fed President Narayana Kocherlakota noted recently that the Fed would need to sell a "nontrivial" amount of its holdings, such as $15 billion to $25 billion a month, to return its balance sheet to precrisis levels.
But it is difficult to see policy makers pushing sales quickly since the housing market is still on shaky ground. "I don't think we'll have asset sales at all this year and frankly I'm skeptical they'd do them in 2011," says Barclays analyst Joseph Abate. "There just isn't a pressing need."
Some $200 billion of mortgage holdings, or about 18% of the Fed's total, he adds, is set to roll off by the end of next year anyway as the securities mature. Shrinking mortgage holdings in that way is more likely since it won't put pressure on markets. The Fed may also trim the balance sheet through auctions of other holdings.
Wednesday's statement should offer some insight on the Fed's time line. What will remain unclear is whether the Fed stays too cautious for too long.
Printed in The Wall Street Journal, page C1
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