Fed ends bond-buying, promises hold on interest rates for
By Kevin G. Hall
McClatchy Washington Bureau October 29, 2014
WASHINGTON — The Federal Reserve on Wednesday formally ended its controversial purchases of government and mortgage bonds, and in doing so cleared the decks for eventual increases in interest rates, last seen in 2008.
The nearly unanimous decision by the rate-setting Federal Open Market Committee – only one member of the 10-person panel voted “no” – brought to a close a program that saw the Federal Reserve make more than $4 trillion in bond purchases, over three incarnations, designed to keep the economy moving forward after the financial crisis.
In a statement, the committee said it had seen “substantial improvement” in job growth and “sufficient underlying strength in the broader economy” with little sign of inflation. “Accordingly, the committee decided to conclude its asset purchase program this month,” the statement said.
The purchases were controversial when launched by then-Fed Chairman Ben Bernanke. His vice chairman, Janet Yellen, is now the Fed chief, in charge of winding down the effort.
The program, technically called quantitative easing, had been blasted by critics, who warned it could spark runaway inflation or dangerously weaken the U.S. dollar. Neither happened. But the Fed still has all those bonds on its books, so ending the bond buying is just a first step in a drawn-out wind-down.
Now that the program is ending, some turmoil is expected in financial markets. That’s because the effort was designed to encourage investors to take risks: Lowering the rate of return on such safe instruments as U.S. Treasury bonds was intended to drive investors into stocks, commodities, corporate bonds and other less-certain bets that have risen in value since the 2008 financial crisis.
Now those financial markets must determine what the proper price is for stocks and bonds in the absence of the Fed’s bond purchases.
What comes next from the Fed also has no clear answer, and that too roils markets. More detail is expected after the Fed’s final meeting this year in mid-December, when Yellen holds a news conference.
In its statement, the committee said it intended to keep the federal funds rate – the interest rate charged for overnight loans to banks – at less than 0.25 percent “for a considerable period of time.” But there are still many questions to be answered, including how fast the Fed will sell the bonds it’s purchased.
“I think this is going to be a multiyear process of working down the balance sheet,” said Sam Bullard, an economist with Wells Fargo Securities in Charlotte, N.C.
Given weakness in the housing sector, he said, the Fed is likely to reinvest earnings from the mortgage bonds it owns in a bid to continue its support of home sales and offset some of the drag from rising interest rates.
An increase in the Fed’s benchmark federal funds rate will be a sign that it thinks things are returning to normal. The funds rate influences the prime rate, the rate lenders charge their most creditworthy customers. Since it’s been near zero for almost six years, allowing the rate to begin rising would be akin to taking the training wheels off a bicycle or a cast off a broken leg. In its statement, the committee gave an ambivalent projection.
“If incoming information indicates faster progress toward the committee’s employment and inflation objectives than the committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated,” it said. “Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.”
“The Fed is saying they’re going to raise interest rates soon, and the market is saying, ‘I don’t think things are good enough to raise rates,’ and the markets are scared,” said Paul Edelstein, an economist with forecaster IHS Global Insight. “They’re wondering if this economy can withstand tightening monetary policy.”
Before the statement was released, most economists had said they expected interest rates to climb slowly, with an increase next June at the earliest. Yellen has said repeatedly that she expects the Fed’s benchmark rate to remain low for an extended period. Still, as rates rise – what economists call tightening – it will mean that mortgages, car loans, student loans and credit cards will become more expensive for consumers.
One reason financial markets worry about rising interest rates is that while the U.S. economy has been hot, the global economy has not. China might miss an already tepid annual growth target of 7.5 percent this year, much of Europe is approaching recession and Latin America’s largest economy, Brazil, is already there. These weigh against U.S. growth in the months ahead.
The Commerce Department will release its economic growth data Thursday for the quarter that ran July through September and it’s expected to be in the range of 3.5 percent annual growth.
Rate hikes slow economic growth in order to thwart inflation, but there’s little evidence presently of a sharp rise in prices. The latest reading on consumer inflation, in September, showed an increase of just 0.1 percent at an annual rate, hardly a sign that prices are about to take off.
Email: email@example.com; Twitter: @KevinGHall.