The Federal Reserve will begin slowing its massive monthly purchases of government bonds after months of economic uncertainty stemming from the COVID-19 pandemic, a first step toward raising its interest rate target.
The central bank announced on Wednesday it will start reducing its monthly purchases of $120 billion in Treasury bonds and mortgage-backed securities. The news came after a highly anticipated two-day meeting of the Fed's monetary policy committee.
The tapering process will begin later this month. The process will entail monthly reductions of $10 billion in bonds and $5 billion in mortgage-backed securities, according to a statement released after Fed leadership's meeting. It also emphasized the plan could change depending on how the economy functions.
"The Committee judges that similar reductions in the pace of net asset purchases will likely be appropriate each month, but it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook," the statement read. "The Federal Reserve’s ongoing purchases and holdings of securities will continue to foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses."
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Some economists had hoped the Fed would have already begun scaling back its ultraloose monetary policies, such as holding interest rates near zero, because of stubbornly high inflation. Fed Chairman Jerome Powell had consistently said the bond purchasing would not ease until “substantial further progress” had been made on meeting the central bank’s employment and inflation targets.
The Fed’s goal of sustained 2% inflation has already been met, although its goal of reaching full employment before raising interest rates is still not likely to occur soon. Wednesday’s news that the bank’s historic asset-purchasing program is being wound down shows the Fed sees the economy as making headway toward those goals, though.
"The Fed is taking the first step in a long, multistage journey of unwinding the extraordinary pandemic stimulus by starting to taper their monthly bond purchases. A less accommodative Fed ultimately means higher interest rates, increased market volatility, and more pedestrian returns for stocks and real estate," said Greg McBride, chief financial analyst at Bankrate.
The Federal Open Market Committee’s meeting in September came on the heels of a disappointing August jobs report that fell well short of what economists had predicted. At the time, Powell said the Fed only needed to see a “decent” September report to begin tapering its purchases in November.
September’s jobs report was not too reassuring. The economy added just 194,000 new jobs in September as the delta variant held back commerce — below the consensus forecast of 473,000 new jobs.
Inflation has been higher than the Fed anticipated earlier this year, with the banking system recently registering the highest rate in 30 years in the gauge favored by the central bank.
"The Fed’s assessment of inflation continues to waffle. They now say it is 'expected to be transitory.' Just like the subprime mortgage mess was expected to be contained?" remarked McBride after reading the Fed's most recent statement.
During its last meeting, the central bank raised its predictions for this year’s inflation to 4.2%, compared to its June forecast of 3.4%. However, it expects prices to fall back to 2.2% next year, slightly up from its previous prediction of 2.1%. It also revised down its GDP prediction from 7% in 2021 to 5.9% and slashed its growth forecast from 3.8% to 3.3% for next year.
In a press conference Wednesday afternoon, Powell said the Fed is aware of the financial difficulties high inflation poses for consumers, particularly those of limited means. However, he emphasized the central bank’s tools are not able to ease supply constraints.
“Like most forecasters, we continue to believe that our dynamic economy will adjust to the supply and demand imbalances and that as it does, inflation will decline to levels much closer to our 2% longer-run goal,” Powell said. “Global supply chains are complex, they will return to normal function. But the timing of that is highly uncertain.”
Powell’s actions are closely scrutinized as President Joe Biden weighs whether to keep Powell, a Republican, leading the Fed or replace him.
Most Fed watchers expect Biden to keep Powell as chairman given the uncertainty of the U.S. economy and the jitters a sudden shake-up could give the markets. Democrats have also praised Powell’s leadership during the pandemic, and some have hailed his commitment to full employment. Treasury Secretary Janet Yellen, who once led the Fed, has also praised his job performance.
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This week, Biden said he will announce his nominees to the Fed’s board “fairly quickly,” although he has not yet revealed whether Powell will end up keeping his job.
“I’ve been meeting with my economic advisers on what the best choices are,” the president said. “We’ve got a lot of good choices, but I’m not going to speculate now.”