Federal Reserve Signals It May Soon Slow Bond Purchases

Federal Reserve officials indicated on Wednesday that they expect to soon slow the asset purchases they have been using to support the economy and predicted they may raise interest rates next year, sending a clear signal that policymakers are preparing to pivot away from full-blast monetary help as the business environment snaps back from the pandemic shock.

“If progress continues broadly as expected, the Committee judges that a moderation in the pace of asset purchases may soon be warranted,” the policy-setting Federal Open Market Committee said in its September statement. The new phrasing eliminated wording that had promised to assess progress over “coming meetings,” suggesting that a formal announcement of the slowdown could come as early as the central bank’s next gathering in November.

Fed officials face a complex background nearly 20 months since the first coronavirus pandemic shook America’s economy. Consumer spending has risen strongly and businesses have recovered, thanks to repeated government stimulus checks. However, the virus is still prevalent and many adults are not yet vaccinated. This hinders any return to normal.

External threats also loom, including tremors in China’s real estate market that have put financial markets on edge. American partisan wrangling could cause future government spending plans to be ruined or delay the needed debt ceiling raise.

Jerome H. Powell, Fed Chair and his team are dealing with these crosscurrents at a moment when inflation is rising and the labor market, although recovering, remains weak. They are trying to decide when and how to reduce their support for monetary policy, in an effort to keep the recovery on track and prevent financial or economic market overheating.

“The sectors most adversely affected by the pandemic have improved in recent months, but the rise in Covid-19 cases has slowed their recovery,” The Fed stated this Wednesday in its statement.

The Fed has held interest rates low since March 2020. It is now buying $120 million in government-backed bond each month. This is a combination of policies that help keep all types of borrowing inexpensive. This has helped to increase lending and spending as well as boosting economic growth. Officials indicate that slowing down bond purchases is their first step towards normalizing policy.

Speaking after the meeting, Powell said that Fed officials expected the economy to continue growing strongly and that support would be provided by the central bank for as long it was needed. However, he stated that policymakers believe that it will soon come time to cut back on bond purchases. He also said bluntly that an announcement could be made as soon as November.

“Our asset purchases have been a critical tool,” Mr. Powell said, adding that Fed officials believe the economy has made enough progress toward the central bank’s goals of full employment and stable inflation that it may make sense to begin paring back those purchases “if progress continues.”

“My own view would be that the substantial further progress test for employment is all but met,” Mr. Powell said. “I think if the economy continues to progress broadly in line with expectations, and also the overall situation is appropriate for this, I think we could easily move ahead at the next meeting — or not, depending on whether we think those tests are met.”

Powell stated that policymakers discussed the pace at which asset purchases are slowing down. Officials expect the overall bond-buying program will end around the middle next year.

“They want to start the exit,” said Priya Misra, global head of rates strategy at T.D. Securities. “They’re putting the markets on notice.”

The central bank is trying to separate its plans for the federal funds rate — the Fed’s more traditional and more powerful policy tool — from its approach to bond purchases. Powell stated that the key rate will likely remain low for a while.

Officials released a fresh set of economic projections on Wednesday, laying out their predictions for growth, inflation and the funds rate through the end of 2024. Those included the so-called “dot plot” — a set of anonymous individual estimates showing where each of the Fed’s 18 policymakers expect their interest rate to fall at the end of each year.

Half of the policymakers expected one or more interest rate increases by late 2022, with nine penciling in a rate hike next year, up from seven when projections were last released in June. Officials expected rates to remain at 1.8 percent by the end of 2024, which was the first time that the Fed had released 2024 projections.

According to Fed officials, inflation was expected to average 4.2 percent over the final quarter 2021 and fall to 2.2 percent by 2022.

Inflation has been rising rapidly in recent months due to supply-chain disruptions, and other quirks related to the pandemic. The Fed’s preferred metric, the personal consumption expenditures index, climbed 4.2 percent in July from a year earlier.

However, there are concerns about inflation’s future. Some officials fear that inflation will not fall, due to high consumption and newfound pricing power from corporations. Consumers are more likely to accept higher prices.

Others fret that the same one-offs pushing prices higher today will lead to uncomfortably low inflation down the road — used car prices have caused a big chunk of the 2021 increase and could fall, for instance. The same global trends that were causing inflation to drop could again lead to tepid price increases before the pandemic.

A Fed goal of 2 percent annual price growth over time would make it difficult for inflation to be either too high, or too low.

The central bank has been given two tasks by Congress: It is to promote maximum employment and price stability.

This second goal is also elusive. Millions of jobs still remain unfilled despite months of record-setting employment gains. Officials don’t want to raise interest rates to cool down the economy until the labor force has fully recovered. It’s difficult to know when that might be, because the economy has never recovered from pandemic-induced lockdowns before.

If inflation seems to be climbing, slowing down and stopping bond purchases could allow the Fed to be more flexible. Officials indicated that they prefer to not raise interest rates until bond buying ends.

But the central bank has been cautious in announcing its plans for the so-called “taper.” In 2013, when a former Fed chair suggested that a post-financial-crisis bond purchase program would slow, it roiled global markets in what became known as the “taper tantrum.”

Before Wednesday’s announcement, most economists expected the Fed to formally announce a taper plan at its next meeting, which is scheduled for Nov. 2-3.

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