Fed stirs up bond policy to ease $4.5T portfolio
HINTS AT RATE HIKE Janet Yellen, chair of the U. S. Federal Reserve, announces that the Fed will begin to shrink the portfolio of bonds amassed after the 2008 financial crisis. The move reflects a strengthened economy and hints that a rate hike is coming.
• The U. S. Federal Reserve will begin shrinking the enormous portfolio of bonds that it amassed after the 2008 financial crisis to try to sustain a frail economy. The move reflects a strengthened economy and could mean higher rates on mortgages and other loans over time.
The Fed announced Wednesday that it will let a small portion of its US$4.5-trillion balance sheet mature without being replaced, starting in October with reductions of US$ 10 billion a month and gradually rising over the next year to US$ 50 billion a month.
The central bank l eft its key short- term rate unchanged but hinted at one more hike this year — most likely in December. The Fed policy- makers’ updated economic forecasts show an expectation for three more rate increases in 2018.
Stocks turned lower after the announcement before finishing mixed. Bond yields rose, reflecting expectations of higher rates.
John Silvia, chief economist at Wells Fargo, said some investors appeared surprised that the Fed still expects to raise rates by December. With hurricanes Harvey and Irma clouding some economic data — temporarily raising gas prices, likely restraining hiring and potentially depressing growth in the July- September quarter — some analysts assumed the Fed wouldn’t have enough information by December to assess whether the economy had rebounded from the storms.
“A lot of people were thinking ( the Fed) would pass in December,” Silvia said.
At a news conference, Fed chair Janet Yellen said the Fed’s two rate hikes this year and its decision to begin reducing its bond holdings were signs of a solid economy and job market.
“The basic message here is U. S. economic performance has been good,” Yellen told reporters.
Yellen also said the Fed still believes that persistently low inflation — below the Fed’s two-per-cent target for four years — is temporary. She said several factors have held inflation down: A job market still healing from the Great Recession, lower energy prices and a strong dollar, which has reduced the costs of imports.
She said the Fed would adjust its policy if it thought the causes of low inflation had become permanent.
In its policy statement, the Fed took note of Harvey, Irma and hurricane Maria, which it said had devastated many communities. But it said history suggests that the storms were unlikely to affect the national economy over the long run.
The Fed has telegraphed its bond rollback move for months, and investors are thought to be prepared for it. Still, no one is sure how the financial markets will respond over the long run. The risk exists that investors could become spooked by the rising number of bonds being transferred back into private hands. If that were to happen, long- term rates might surge undesirably high, which could weigh on the economy.
To avoid spooking i nvestors, the Fed’s plan for shrinking its balance sheet is so gradual that the total would remain above US$ 3 trillion until late 2019. Some economists say they think the figure could end up around US$ 2.5 trillion, still far above the US$900 billion the Fed held in its portfolio in pre-crisis days.
The question of when and how the Fed will manipulate its main policy lever — its target for short- term rates — in coming months is less clear.
After leaving its benchmark rate at a record low for seven years after the 2008 crisis, the Fed has modestly raised the rate four times since December, 2015, to a still- low range of one per cent to 1.25 per cent.