Fed Announces Plans To Begin Scaling Back Asset Purchases

In a widely expected move, the Federal Reserve announced Wednesday that is has decided to begin scaling back its asset purchases later this month.

The Fed said it plans to reduce its $120 billion in monthly bond purchases by $15 billion per month, citing the substantial further progress the economy has made toward its goals of maximum employment and price stability.

Reflecting the move, the Fed plans to increase its holdings of Treasury securities by at least $70 billion per month and of agency mortgage-backed securities by at least $35 billion per month beginning later this month.

Beginning in December, the central bank will increase its holdings of Treasury securities by at least $60 billion per month and of agency mortgage-backed securities by at least $30 billion per month.

The Fed expects similar reductions in the pace of net asset purchases will likely be appropriate each month but said it is prepared to adjust the pace of purchases if warranted by changes in the economic outlook.

“At first glance, the reluctance to pre-announce the whole month-to-month tapering plan with an end date for mid-2022 could be considered dovish,” Paul Ashworth, Chief U.S. Economist at Capital Economics.

He added, “But the alternative is that some hawkish officials might want to speed up the taper early next year, particularly if inflation continues to run hotter than expected.”

In the statement announcing the decision, the Fed said indicators of economic activity and employment have continued to strengthen amid progress on Covid-19 vaccinations and strong policy support.

The statement also acknowledged supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors, although the Fed continued to describe the factors leading to elevated inflation as transitory.

The Fed noted risks to the economic outlook remain but predicted progress on vaccinations and an easing of supply constraints would lead to continued gains in economic activity and employment as well as a reduction in inflation.

Along with the plan to begin reducing its asset purchases, the Fed also announced its widely expected decision to keep the target range for the federal funds rate at 0 to 1/4 percent.

The central bank said it expects interest rates to remain at near-zero levels until labor market conditions have reached levels consistent with its assessments of maximum employment and inflation is on track to moderately exceed 2 percent for some time.

“While markets are betting the Fed will be forced to raise rates rapidly after it tapers its QE program, the statement maintained clear guidance on the federal funds rate remaining at the effective lower bound,” said Gregory Daco, Chief U.S. Economist at Oxford Economics.

He added, “We continue to expect the Fed will wait until December 2022 to proceed with rate liftoff, but we can’t ignore the risk of a policy mistake with the Fed tightening too early in the face of supply-driven inflation.”

In his post-meeting press conference, Fed Chair Jerome Powell stressed that the decision to begin tapering asset purchases does not reflect a direct signal regarding interest rate policy.

“We continue to articulate a different and more stringent test for the economic conditions that would need to be met before raising the federal funds rate,” Powell said.

Powell argued there is still ground to cover to reach maximum employment both in terms of employment and participation.

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