Fed Sets October End for Bond Buying
Central Bank Officials See Economy Gathering Strength; Timing for Rate Hikes Still Under Debate
By JON HILSENRATH and PEDRO NICOLACI DA COSTA
Updated July 9, 2014 7:07 p.m. ET
Federal Reserve officials agreed to end the central bank’s bond-buying program by October. WSJ’s Pedro da Costa has the details on the News Hub with Sara Murray. Photo: Getty Images.
Federal Reserve officials agreed at June’s policy meeting to end their bond-buying program in October, putting an explicit end date on the experiment for the first time and closing a controversial chapter in central-banking annals with results still the subject of immense debate.
The central bank has reduced bond purchases in $10 billion increments this year, to $35 billion a month from a peak of $85 billion. The tentative plan outlined in minutes of June’s meeting, released Wednesday, is to reduce bond purchases in increments at its next three policy meetings, including a $15 billion reduction in October, leaving it to buy no bonds in November.
“If the economy progresses about as the [Fed] expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting,” the Fed said in the minutes.
The meeting occurred before recent reports showing strong job growth in June, but an even larger economic contraction in the first quarter than previously thought. The odd mix of declining unemployment during a period of subpar growth is one of many conundrums officials are grappling with.
The Fed faces tough decisions in the months ahead about the timing and pace of interest-rate increases. Fed Chairwoman Janet Yellen wants to hold off to avoid choking off the recovery, but if she waits too long she could spur inflation or a financial bubble. Most officials at the June meeting indicated they expect the first rate hike to come next year.
For now, the decision to end the latest round of bond purchases, also known as quantitative easing, marks a momentous step for the central bank.
The Fed announced its first bond purchases during the heat of the financial crisis in late 2008. It launched successive rounds of purchases in 2010, 2011 and 2012, each time ramping up new programs after the economy underperformed. Its total holdings of bonds, loans and other assets have grown from less than $900 billion to $4.4 trillion, a level most officials considered out of the question a few years ago.
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John Williams, president of the Federal Reserve Bank of San Francisco, said in an interview that the economy has demonstrated in the past year it can stand without the additional stimulus the Fed has provided through bond purchases.
“We’ve seen huge improvement in the labor market, we’ve seen inflation moving back,” he said. “The reality is that we’re closer to our goals.”
The bond programs aimed to hold down long-term interest rates and drive investors into riskier holdings like stocks or corporate debt. That in turn was intended to stimulate borrowing, lending, spending, investing and hiring.
The jobless rate has fallen from 7.8% when the Fed announced a round of purchases in September 2012 to 6.1% in June. However, economic growth has continually disappointed. Official measures of inflation have run below the Fed’s 2% goal for two years but show signs of picking up of late.
Critics have long argued the programs risk causing a financial bubble or excessive inflation, without giving an obvious boost to hiring. Fed officials and other supporters of the program argue it has helped the economy grow faster than it would otherwise grow, with limited risk.
Stephen Stanley, an economist with Pierpont Securities, said in an interview the early version of bond buying in 2009 “made a huge difference” in settling mortgage markets during the crisis.
But he argued that the Fed’s purchases have become less effective the longer they’ve gone on. The latest program, he said, has done little to boost growth and is instead brewing instability in financial markets by driving investors into risky assets. In a note to clients after the minutes, he warned, “This is an economic train wreck playing out in slow motion.”
Others say all the programs have been crucial in supporting the economy. “If you look at it in the arc of the 2008 to 2013 period it’s been a very important complementary force to help the Fed keep interest rates low, to anchor inflation expectations and to support the recovery,” said Bruce Kasman, economist at J.P. Morgan Chase & Co.
Following the release of the minutes, U.S. stocks extended gains, with the Dow Jones Industrial Average climbing 78.99 points, or 0.5%, to 16985.61.
Investors are now turning their attention away from bond purchases and toward the timing of Fed interest-rate increases. The central bank has kept short-term rates near zero since December 2008 and gave no indication in the minutes that rates are going up soon, a source of encouragement for investors who tend to buy stocks when rates are low.
The minutes showed Fed officials deep into discussions about managing the mechanics of pushing rates up. This will be a more difficult task than usual because the Fed has flooded the financial system with money since 2009, which puts persistent downward pressure on rates.
Officials also are carefully trying to manage the public’s expectations about their next moves. For several years, they tried to offer assurances that rates would stay exceptionally low. Now, they are expressing more uncertainty about how long they will stay low.
“Some participants suggested that the Committee’s communications about its forward guidance should emphasize more strongly that its policy decisions would depend on its ongoing assessment across a range of indicators of economic activity, labor market conditions, inflation and inflation expectations, and financial market developments,” the minutes said.
Officials have publicly encouraged a widely held view in financial markets that rate increases won’t start until mid-2015, but some expressed a worry at the June meeting that investors are getting complacent about the path ahead.
“Favorable financial conditions appeared to be supporting economic activity,” the minutes said. “However, participants also discussed whether some recent trends in financial markets might suggest that investors were not appropriately taking account of risks in their investment decisions.”
Volatility in stock, bond and currency markets has been unusually low in recent months. That could be a sign “market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy,” the Fed said.
Ms. Yellen expressed a similar concern in a speech last week at the International Monetary Fund, but she said this concern wasn’t serious enough to alter the Fed’s interest-rate plans and expressed a broader skepticism about using rate hikes to prick financial bubbles.
Behind the Fed’s decision to wind down the bond-buying program is a view that the economy is gradually strengthening, despite a first-quarter stumble in growth. However, in almost every area they discussed, officials appeared to strain to come to a common view about how the economy is evolving.
On the central issue of the job market, for example, they expressed a wide range of views. “Many judged that slack remained elevated,” the minutes said, but “several participants pointed out that both long- and short-term unemployment and measures that include marginally attached workers had declined.”
“Most participants projected the improvement in labor market conditions to continue, with the unemployment rate moving down gradually over the medium term,” the minutes concluded.