Coverage: Fed announces October deadline

The minutes of the Federal Reserve Board’s last meeting outlined the plan to end its historic bond buying in October. While not unexpected, it does indicate that despite some recent setbacks, officials feel the economy is on the right track.

The Wall Street Journal’s Jon Hilsenrath had these details:

Federal Reserve officials agreed at their June policy meeting to end the central bank’s bond-buying program by October, closing a chapter on a controversial experiment in central-banking annals with results still the subject of immense debate.

Officials have been winding down their purchases of Treasury bonds and mortgage-backed securities in incremental steps since January and have said they expect to end the program later this year, but until now haven’t been explicit about the end date.

“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 minutes released Wednesday from its June policy meeting.

Following the release of the minutes, U.S. stocks extended gains as investors focused on the absence of any clear signal on rate increases. Treasury bonds rose following the Fed minutes, pushing yields lower.

With the wind-down of the bond-buying program settled, the Fed faces tough choices about the timing and pace of interest-rate increases in the months ahead. As this debate intensifies, officials have been moving away from giving the public firm guidance about interest rates and trying to stress the uncertainty about the path ahead.

The New York Times story by Binyamin Appelbaum added that the move was unlikely to change when the Fed would raise interest rates:

The minutes said that ending the purchases in October rather than December was not intended to signal any change in the timing of the next step in the Fed’s retreat – the first increase in its benchmark interest rate since December 2008. Investors generally expect the Fed to start raising interest rates next summer.

“Most participants viewed this as a technical issue with no substantive macroeconomic consequences and no consequences for the eventual decision about the timing of the first increase in the federal funds rate,” the minutes said.

Even after the Fed ends the expansion of the portfolio, it plans to maintain the size of its holdings by reinvesting payments of principal. Those purchases, primarily of mortgage bonds, have totaled about $16 billion a month so far this year.

The minutes said that most Fed officials favored maintaining this reinvestment policy until after the Fed had started to raise interest rates, to focus public attention on what officials regarded as the most important lever of monetary policy.

Paul Davidson wrote for USA Today that the end to the purchases would carry some significance – however slight:

Yet while Fed officials have clearly said the bond buying would be halted this year, closing out the program would carry symbolic significance. The purchases have held down long-term interest rates for several years, spurring purchases of homes and factory equipment. The most recent phase of the bond-buying program began in September 2012, but the Fed has bought well over $3 trillion in bonds since the 2008 financial crisis.

Fed policymakers “generally agreed” that “it would be appropriate to complete asset purchases with a $15 billion reduction … in order to avoid having a small remaining level of purchases receive undue focus among investors,” according to the minutes.

Reuters pointed out in a piece by Howard Schneider, Michael Flaherty and Jonathan Spicer that the Fed’s balance sheet will begin declining, a subject of some debate:

Ending reinvestment will put the central bank’s balance sheet on a declining path, and some members argue that should not take place until interest rates have been increased.

In addition, the minutes indicated the reinvestment decision may not be an all-or-nothing choice: the central bank may try to “smooth the decline in the balance sheet,” perhaps by letting some maturities expire each month and reinvesting the proceeds of others.

The Fed’s exit strategy is complicated because its stimulus programs flooded the financial system with $2.6 trillion that has ended up back at the Fed as excess bank reserves. With that much money on hand, banks have little need to borrow from each other in the federal funds market – stifling an important interest rate tool.

The New York branch of the U.S. central bank has been testing the reverse repo facility since September as a way to help control short-term interest rates, and has seen strong demand from money market funds and other bidders. In reverse repos, the Fed borrows funds overnight from banks, large money market mutual funds and others. The tool is designed to mop up excess cash in the financial system which could keep market rates too low if left in circulation.

While the announcement is only really a reinforcement of previous ones, it’s still significant that the federal government does have plans for stopping its bond purchases. No one knows what will happen once the money stops flowing, but the Fed is betting that the economy is strong enough to handle it. The real shock will be if officials have to reverse their well-publicized plans.