US Fed announces plan to slow its bond-buying programme

NEW YORK (NYTIMES) – Federal Reserve officials took their first major step towards withdrawing monetary policy support as the economy heals from pandemic disruptions and inflation remains sharply elevated, laying out a plan to slow their asset buying programme.

“In light of the substantial further progress the economy has made towards the committee’s goals since last December, the committee decided to begin reducing the monthly pace of its net asset purchases,” the Fed said in a statement released on Wednesday (Nov 3), referring to its policy setting group.

The central bank has been buying US$120 billion (S$160 billion) in mortgage-backed securities and Treasury bonds each month to keep cash flowing through the financial system but will reduce that by US$15 billion per month starting this month, it said.

Although it will slow those purchases, the Fed’s main policy interest rate, which affects borrowing costs across the economy, remains set near zero.

Officials have signalled that they will use their policy rate, which is the more powerful of the Fed’s tools, to help the recovery along until the labour market is more fully healed.

But that plan could be upended by rapidly rising prices. The Fed is tasked with achieving full employment and keeping price gains low and stable, and if inflation does not fade next year as policymakers expect, they might decide to lift interest rates to slow down demand and keep inflation in check.

Prices picked up by 4.4 per cent in the year through September, well above the Fed’s 2 per cent goal. The price gains have been decelerating in recent months after popping this summer, but it is possible that rising rents, climbing labour costs and continued supply chain disruptions could keep them elevated in the months ahead.

In their November policy statement, officials noted the rapid pace of price increases but predicted that they will fade.

“Inflation is elevated, largely reflecting factors that are expected to be transitory,” they said. “Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors.”

Fed officials are willing to tolerate a temporary bout of inflation as the economy reopens from the pandemic, but if consumers and businesses come to expect persistently higher prices, that could spell trouble. High and erratic inflation that persists would make it hard for businesses to plan and might eat away at wage increases for workers who lack bargaining power.

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Fed chairman Jerome Powell has signalled that he and his colleagues would react if they believed that rapid price gains were going to be sustained.

Slowing bond purchases now will leave them more nimble going forward. Many officials would not want to lift interest rates while they are still making large bond purchases, because doing so would mean that their two tools are working against one another. Finishing the buying programme sooner will leave central bankers in a position to lift borrowing costs if a rate increase is deemed necessary.

Fed officials have tried to separate the path to slow bond buying, commonly called “tapering,” from their plans for interest rates. Even so, investors increasingly expect rate increases to start midway through 2022, market pricing suggests.

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But there are potential costs to lifting borrowing costs early or aggressively. Many workers have yet to return to the job market after employment plummeted amid pandemic lockdowns. Some employees may have retired, but many people who are now on the labour market’s sidelines may trickle back to the job search as child care issues are resolved and health concerns wane.

If the Fed slows the economy before they do that, it could be harder for them to move into new jobs, leaving the economy with less potential and families with fewer pay cheques.

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