Fed leaves rates alone but moves closer to selling off bonds
Bond sell-off
The Federal Reserve is keeping its key interest rate unchanged at a time when inflation remains persistently low. But it signaled Wednesday that it’s edging closer to gradually shrinking its bond holdings, a step that would likely boost long-term borrowing rates including mortgages.
The Fed noted Wednesday in a statement that inflation has stayed undesirably low even though the job market keeps strengthening, with the unemployment rate just 4.4 percent. Normally, solid hiring drives up wages and prices. But the Fed’s preferred inflation gauge has moved further below its 2 percent target.
Too-low inflation can slow economic growth by causing people to delay purchases if they think they can buy a product for a lower price later.
The central bank decided after its latest policy meeting to leave its key rate unchanged in a range of 1 percent to 1.25 percent after having raised rates twice this year. The Fed says it still envisions further “gradual” rate hikes. But many economists say they foresee no further rate increases this year unless inflation picks up. If inflation does accelerate, the Fed may feel comfortable raising rates again in December.
Addressing its bond portfolio, the Fed slightly changed its statement to say such a reduction would begin “relatively soon,” provided the economy
improves further. Many economists think the Fed will begin shrinking its balance sheet sometime this fall.
The Fed’s balance sheet has soared fivefold — to $4.5 trillion — since the summer of 2008, just before the financial crisis erupted. The balance sheet grew as a result of bond purchases by the
Fed that were intended to lower long-term loan rates and stimulate a struggling economy.
Now, the reverse is expected: A sell-off of the bonds, even a gradual one, would likely make some long-term loans for consumers and businesses more expensive.
“The Fed is shifting their immediate focus away
from short-term interest rates and toward beginning the normalization process of the $4.5 trillion balance sheet,” noted Greg McBride, chief financial analyst at Bankrate.com.
McBride said this shift could represent a “reprieve for credit card holders and home equity borrowers,” whose rates are more influenced by the Fed’s benchmark
rate.
Many economists say they think the Fed could announce after its September meeting a precise date for the start of the bond reductions. Some foresee the process beginning in October.
“A start date for the balance sheet normalization is all teed up for the September meeting,”
McBride said.
The Fed has sought to assure investors that the process would be extremely gradual. In its statement Wednesday, it pointed to the plan that it laid out in June: Monthly reductions of the Fed’s bond portfolio would start at a level of no more than $6 billion for Treasurys and $4 billion for mortgage bonds.