Fed Dials Back Bond Purchases, Plots End to Stimulus by June
Central bank affirms forecast that factors driving high inflation are “expected to be transitory”
The Federal Reserve approved plans to begin scaling back its bond-buying stimulus program this month and end it by June, a major step toward withdrawing its aggressive, pandemic-driven economic support amid a recent inflation surge.
Fed officials in their postmeeting statement Wednesday said they still anticipated elevated inflation would fall because high readings are “largely reflecting factors that are expected to be transitory.”
“Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors,” the statement said.
The Fed cut its short-term benchmark rate to near zero when the coronavirus pandemic hit the U.S. economy in March 2020. It held rates at that level on Wednesday.
It also has been buying at least $120 billion a month in Treasury and mortgage securities—initially to stabilize financial markets and later to hold down longer-term interest rates. The Fed’s holdings of those securities has more than doubled since March 2020 to around $8 trillion.
The Fed will reduce its bond purchases by $15 billion per month in November and by a further $15 billion in December, the central bank said Wednesday. It said similar reductions in the pace of net purchases “will likely be appropriate each month,” though officials would be prepared to adjust that pace “if warranted by changes in the economic outlook.”
Fed Chairman Jerome Powell has so strongly signaled in advance the decision on the asset purchases that investors have shifted their focus to how he will characterize inflation risks at his news conference later Wednesday—and the implications for how soon the central bank might raise interest rates.
Fed officials don’t want to lift rates until after they have ended the bond purchases. Mr. Powell has slightly moved up plans to wind down those purchases, relative to earlier market expectations, as inflation has soared this year.
Brisk demand for goods, disrupted supply chains, temporary shortages and a rebound in travel have pushed 12-month inflation to its highest readings in decades. Core inflation, which excludes volatile food and energy prices, rose 3.6% in September from a year earlier, according to the Fed’s preferred gauge.
From April through September, the Fed’s statement described high inflation as “largely reflecting transitory factors.” Wednesday’s statement included additional language to characterize why officials still expect prices to decline. “Progress on vaccinations and an easing of supply constraints are expected to support continued gains in economic activity and employment as well as a reduction in inflation,” it said.
Since officials’ previous meeting in September, inflation data have hinted at a potential broadening in price pressures and at the prospect that prices for certain items such as used cars, which witnessed sharp gains earlier this year, have started climbing once more.
While the data don’t necessarily disprove the Fed’s earlier expectations that certain price increases tied to the reopening of the economy this year from the pandemic will fade over time, it does at least augur a longer interval of elevated inflation readings.
“Supply-side constraints have gotten worse. The risks are clearly now to longer and more-persistent bottlenecks, and thus to higher inflation,” Mr. Powell said last month.
Higher inflation readings and policy pivots by other similarly-situated central banks have led bond investors to anticipate that the Fed will raise rates next summer, after it stops buying bonds, and again later in the year.
Mr. Powell has been seeking a middle ground that assures investors the Fed is closely monitoring inflation risks while not appearing so worried that he leads markets to anticipate an even faster pivot to tighter money. The expectation that inflation-adjusted interest rates will remain low have buoyed global asset prices. The Fed risks triggering new economic or financial stress by shifting abruptly.