Washington: The Federal Reserve on Wednesday released details of its plan to reverse nearly six years of easy money as it nears the end of its trillion-dollar stimulus campaign.
The move comes amid an economic recovery that looks increasingly sustainable, even if it is not as robust as anticipated. The central bank released a more upbeat forecast for the job market Wednesday, predicting the unemployment rate would fall to between 5.9 and 6 per cent by the end of the year. It slightly downgraded its assessment of economic growth this year to between 2 and 2.2 per cent.
“The economy is continuing to make progress,” Fed Chair Janet Yellen said Wednesday in a news conference. But, she added, “the labour market has yet to fully recover.”
Major US stock markets closed modestly up after falling into negative territory shortly after the Fed’s official policy statement was released. The blue-chip Dow Jones industrial average gained 0.2 per cent, but it was enough to notch a record high. The broader Standard & Poor’s 500 index closed up 0.1 per cent.
The improving outlook means that the recovery no longer needs as much support from the nation’s central bank. Since the start of this year, the Fed has been slowly reducing the amount of money it is pumping into the economy. The central bank said Wednesday that it will reduce its purchases of Treasurys and mortgage-backed securities to $15 billion (Dh55 billion) in October, down from $85 billion a month last year. The Fed expects to end the programme altogether when it meets next month.
Maturing securities
Still, the Fed said it will maintain the size of its balance sheet — which stands at $4.4 trillion — for now. The Fed holds more than four times as many assets as it did before the 2008 financial crisis.Although the central bank said Wednesday that it is committed to shrinking the balance sheet to a more normal size, it formally announced that it does not plan to sell any of its assets,a reversal of the plan laid out three years ago.
Instead, the Fed said it will eventually stop reinvesting maturing securities and let them run off. But the central bank said Wednesday that process will not start until after it has successfully raised its benchmark interest rate.
Officials gave few clues of when that pivotal moment might come. The Fed has kept a key short-term interest rate at zero since 2008, a controversial practice that has helped lower the cost of borrowing for consumers and businesses but has also helped fuel record gains on Wall Street that critics worry could foreshadow the next financial bubble.
In its official policy statement, the central bank retained language stating that the interest rate would remain at zero for a “considerable time” after the bond purchases end. The Fed has used some variation of that phrase for two years, and several central bank officials have called for a new description in light of the recovery’s progress. Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser dissented from Wednesday’s statement, saying that it did not sufficiently convey the possibility that the rates will have to rise sooner rather than later.
But Yellen emphasised that officials are not constrained by any timeline and will remain flexible in their response to the recovery.
Moving cautiously
“There is no fixed, mechanical interpretation of the time period,” she said Wednesday. “It is highly conditional, and it is linked to the committee’s assessment of the economy.”
The Fed’s reluctance to make a change suggests that it is moving cautiously as it considers when to raise interest rates. Officials are worried that increasing rates too early or abruptly could undermine the economy’s momentum. But some critics point out that waiting too long could foster financial instability and force the Fed to play catch-up later.
Government data released Wednesday showing that the rise in consumer prices slowed from 2 per cent to 1.7 per cent in August gives officials some breathing room. With inflation in check, the central bank can continue to goose the recovery in hopes of lowering unemployment.
“The US economic recovery seems to be on firmer ground based on economic releases in recent months, and we believe the Fed is concerned about complacency among investors,” said Patrick Maldari, senior investment manager at Aberdeen Asset Management. “Both are reasons to expect the Fed to raise rates at some point in the second half of 2014, in our opinion, but they appear to be in no rush.”
Tight boundaries
According to the forecasts released Wednesday, most Fed officials expect the central bank’s benchmark rate to be between 1 and 2 percent at the end of 2015. That range suggests there is slightly more agreement among officials over the appropriate level for rates than there was during the Fed’s last meeting in July: Fewer officials believe the rate should be below 1 per cent or above 2 per cent. The consensus at the central bank for rates in the long run remained between 3.75 and 4 per cent.
The Fed said Wednesday that it will rely on several new tools when it does decide to raise rates. Traditionally, the central bank has targeted the interest rate at which banks lend to each other overnight, known as the federal funds rate. In the future, it plans to use the interest paid to banks on reserves held at the Fed to influence the federal funds rate. In addition, it will set the rate at which non-bank financial institutions can park money at the Fed overnight at a slightly lower level than the federal funds rate. Together, the two new tools should create tight boundaries that the Fed hopes will ensure it retains control of the rudder of the economy.
