The Federal Reserve said it would begin scaling back its massive $120bn monthly bond-buying programme this month, a critical milestone for a US economy that is recovering from the pandemic and contending with surging inflation.
The decision is the culmination of months of debate among Fed officials about the level of support the world’s largest economy needs as price pressures begin to extend beyond the sectors most sensitive to the post-pandemic reopening.
Markets expect the Bank of England, which meets on Thursday, to raise interest rates for the first time since 2018. Investors are betting that the European Central Bank could follow suit next year despite recent pushback from its president Christine Lagarde.
Roaring consumer demand in the US has collided with acute supply chain disruptions, causing prices to jump in some sectors for longer than central bankers had anticipated. Rising rents coupled with wage pressures and a severe shortage of workers have given rise to concerns that inflation will prove more persistent than the Fed had initially expected.
Against the backdrop of a robust recovery, the Federal Open Market Committee ended its two-day policy meeting with a pledge to reduce its purchases of Treasury securities by $10bn a month. The central bank will also reduce its purchases of agency mortgage-backed securities by $5bn a month.
The FOMC said it was able to withdraw the stimulus because it had achieved “substantial further progress” towards its twin goals of maximum employment and inflation that averages 2 per cent.
The tapering process is set to begin in mid-November, which suggests the stimulus programme will cease in June 2022. The purchases would be reduced by the same amount in December and further reductions were deemed to “likely be appropriate” each month thereafter.
The Fed committee said it was “prepared to adjust the pace” of the tapering process “if warranted by changes in the economic outlook”. At a press conference following the announcement, Jay Powell, Fed chair, said the central bank was prepared to “speed up or slow down” as needed.
“If we feel like something like that is happening, then we’ll be very transparent. We wouldn’t want to surprise markets,” he said, adding that even after the Fed stops expanding its balance sheet, its holdings of securities will continue to “support accommodative financial conditions”.
On Wednesday, the Fed also tweaked the language it used to describe the inflationary outlook in a tacit if subtle admission that higher prices could persist for longer than it had originally anticipated. It said that the factors driving upward pressure on prices is “expected to be transitory”, whereas previous statements said inflation was being largely driven by “transitory factors”.
At the press conference Powell underscored the severity of the supply and demand imbalances that have contributed to “sizeable price increases in some sectors”. He stressed that the Fed’s view was that these bottlenecks would eventually abate and help bring down prices, although they would persist “well into next year”.
He noted it was “highly uncertain” when inflation will eventually moderate, but said it could be moving down by the second or third quarter of next year.
The central bank’s preferred inflation gauge, the core personal consumption expenditure index — which strips out volatile items such as food and energy prices — rose 3.6 per cent in September from a year earlier.
No adjustment was made to the Fed’s main policy rate, which is tethered near zero, and Powell reiterated that the economic bar for raising rates was far higher than that for tapering.
“It is time to taper, we think, because the economy has achieved substantial further progress toward our goals,” Powell said. “We don’t think it’s time yet to raise interest rates. There is still ground to cover to reach maximum employment, both in terms of employment and in terms of participation.”
“We think we can be patient,” he added later.
Powell stressed that the Fed would be watching “carefully” to ensure the economy is evolving in line with the central bank’s expectations and “will not hesitate” to use its tools if necessary.
Also on Wednesday, the Treasury said it would reduce the amount of debt it issues this quarter, as funding needs for fiscal projects have waned. It is the first cut to Treasury bond auction sizes in five years and provides a counterweight to the Fed’s taper, analysts say.
“It’s almost fortuitous that it is happening this way. It’s certainly good for the Treasury market — it will help offset some of the demand loss,” said Gennadiy Goldberg, senior US rate strategist at TD Securities.
Trading was choppy in the US government debt market after the announcement, with the biggest move in longer-dated, inflation-sensitive yields. Stocks closed at record highs.
Eurodollar futures, a closely watched measure of interest rate expectations, were pricing in a rise in rates beginning in autumn 2022.
Additional reporting by Kate Duguid in New York