Saturday, October 1 2022

The Federal Reserve remains open to reducing its purchases of government bonds and mortgage-backed securities later this year, but will not commit to doing so as long as the pandemic’s impact on jobs remains uncertain, Fed Chairman Jerome Powell said in a much-anticipated speech on Friday.

Speaking at an economic policy symposium in Jackson Hole, Wyoming, Powell continued to walk the policy tightrope the Fed has held onto all summer. As it prepares to withdraw some of the support it gave to the economy during the pandemic, the Fed is hoping to avoid panicking bond investors and creating a “tantrum” that pushes rates up. soaring interest.

At the last Fed meeting in July, “I was of the opinion, like most participants, that if the economy was going broadly as expected, it might be appropriate to start reducing the pace of asset purchases. this year, ”said Powell. “The month that followed brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will carefully assess incoming data and changing risks. “

Powell’s speech – who made it clear that if the Fed cuts it won’t necessarily signal an intention to hike interest rates in the short term – succeeded in appeasing investors in stocks and bonds.

Stock indexes that track publicly traded companies large and small, including the Dow Jones Industrial Average, the S&P 500 and the Nasdaq composite, all posted strong gains on Friday, as investors sighed in relief as the Fed did not plan to abruptly withdraw support for the economy until it was sure the recovery is on track.

When investors are bullish on stocks, it often creates problems for bonds. If investors sell bonds, it pushes up yields. But yields on 10-year Treasuries – an indicator of mortgage rates – fell on Friday, as investor demand for government debt held steady.

Powell “stuck to the script in his Jackson Hole speech,” said Ian Shepardson, chief economist at Pantheon Macroeconomics. “Anyone hoping to have direction on when the taper was going will have been disappointed, but it was never likely.”

While the Fed keeps a close watch on inflation, it won’t be ready to start declining until it sees a further improvement in the employment situation – and the Delta coronavirus variant poses new risks for the recovery, Shepardson said.

“We still think it’s reasonable to expect the announcement of the reduction in November, but it could easily be delayed if the post-Delta rebound takes longer than expected,” Shepardson said.

The Fed’s purchases of government debt and mortgage-backed securities are an emergency measure also used after the 2007-09 recession. Although the Fed’s “quantitative easing” was supposed to be temporary, the Fed had only started unwinding more than $ 4 trillion in assets acquired during the Great Recession when the pandemic hit.

Now, as the Fed continues to add $ 120 billion per month to its balance sheet each month, these debt holdings approach $ 8 trillion, making it harder for the Fed to unwind its position without unintended consequences. .

With many inflation indicators that have skyrocketed in recent months and house prices rising, the Fed is under pressure from Republicans and West Virginia Democratic Senator Joe Manchin to decrease, Politico reports.

Not all Fed policymakers share Powell’s belief that inflation is transitory. Five regional Fed chairmen have told CNBC they are prepared to cut back on Fed asset purchases.

Fed’s quantitative easing approaches $ 8 trillion

In more normal times, the Fed’s primary monetary policy tool is to adjust the short-term fed funds rate, which is the rate that banks charge each other for overnight loans. When the economy grows too fast and inflation exceeds the Fed’s target, it can raise the fed funds rate, making borrowing more expensive. When the economy falters, the Fed can cut short-term rates to encourage borrowing and stimulate growth.

The federal funds rate

Once the Fed cuts the federal funds rate to zero – as it did during the 2008 mortgage crisis and the start of the pandemic in March 2020 – it can turn to quantitative easing by last resort.

According to the minutes of the Federal Open Market Committee’s July meeting, most members are open to phase-down by the end of the year.

“Looking ahead, most participants noted that, provided the economy evolves broadly as they expected, they felt it might be appropriate to start reducing the pace of asset purchases this time. year “, the minutes indicate. Several other members said the reduction “is more likely to become appropriate early next year.”

In Jackson Hole, Powell made it clear that any decision to start cutting gradually would not mean that the Fed is ready to start raising rates in the short term.

“The timing and pace of the upcoming reduction in asset purchases will not be intended to send a direct signal about when to take off interest rates, for which we have articulated a different and significantly stricter test,” Powell said.

“We have said that we will continue to hold the target range for the federal funds rate at its current level until the economy reaches conditions consistent with maximum employment, and inflation has reached 2% and is in. going from moderately exceeding 2% for a while. We have a long way to go to achieve maximum jobs, and time will tell if we have hit 2% inflation on a sustainable basis. “

Email Matt Carter

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