Fed to start backing down on $120 billion-a-month stimulus program

The Fed (Federal Reserve, US central bank) said it will begin phasing out its $120 billion (BRL 680 billion) monthly bond purchase program this month, a critical milestone for the burgeoning US economy. recovers from the pandemic and faces rising inflation.

The decision is the culmination of months of discussion among Fed officials about the level of support needed for the world’s largest economy, as price pressures begin to extend beyond sectors most sensitive to post-pandemic reopening.

The move corresponded to sudden actions by several central banks around the world to tighten monetary policy, including the Reserve Bank of Australia and the Bank of Canada.

​Markets predict that the Bank of England, which meets on Thursday (4), will raise interest rates for the first time since 2018. Investors are betting that the European Central Bank could do the same next year, despite the recent retreat of its president, Christine Lagarde.

Soaring consumer demand in the US has collided with sharp disruptions in the supply chain, causing prices to soar in some sectors for longer than central banks had predicted. Rising rents, coupled with wage pressures and a severe shortage of workers, have raised concerns that inflation will prove more persistent than the Fed initially expected.

Against the backdrop of a robust recovery, the Federal Open Market Commission (Fomc) ended its two-day policy meeting with a pledge to cut Treasury bond purchases by $10 billion. $56.6 billion) per month.

The central bank will also reduce its purchase of mortgage-backed agency bonds by $5 billion (R$28.3 billion) a month.

The Fomc said it is able to withdraw the stimulus because it has achieved “substantial further progress” towards its dual target of maximum employment and average inflation of 2%.

The reduction process is scheduled to start in mid-November, which suggests that the stimulus program will end in June 2022. Purchases would be reduced by the same amount in December, and other reductions were deemed “probably appropriate” each month thereafter. .

The Fed committee said it was “ready to adjust the pace” of the taper process “if warranted by changes in the economic outlook.” At a press conference following the announcement, Fed chairman Jay Powell said the central bank is prepared to “speed up or slow down” as needed.

“If we feel that something like this is happening, we will be very transparent. We don’t want to surprise the markets,” he said, adding that even after the Fed stops expanding its balance sheet, its bonds will continue to “support accommodative financial conditions”.

On Wednesday, the Fed also modified the language used to describe the inflationary outlook in a tacit, albeit subtle, admission that higher prices could persist longer than it had originally anticipated. Powell declared that the factors driving the upward pressure on prices “should be transitory”, while previous statements said that inflation was being mainly driven by “transitory factors”.

At the press conference, Powell highlighted the seriousness of the supply and demand imbalances that have contributed to “considerable price increases in some sectors”. He emphasized that the Fed’s view is that these bottlenecks will eventually ease and help bring prices down, but that they will persist “until much of next year.”

He noted that it is “highly uncertain” when inflation will eventually moderate, but said it could come down in the second or third quarter of next year.

The central bank’s preferred inflation indicator, the core personal consumption expenditure index — which excludes volatile items like food and energy prices — rose 3.6% in September from a year earlier.

No adjustments have been made to the Fed’s key interest rate, which is tied close to zero, and Powell reiterated that the economic barrier to raising interest rates is much higher than reducing it.

“It’s time to slow down, we think, because the economy has made substantial progress toward our goals,” Powell said.

“We don’t think it’s time to raise interest rates. There is still some ground to be covered to reach full employment, both in terms of employment and in terms of participation.”

“We think we can be patient,” he later added.

Powell emphasized that the Fed will be watching “carefully” to ensure that 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 announced that it will reduce the amount of debt it will issue this quarter, as financing needs for fiscal projects have diminished. It is the first cut in Treasury bond auction sizes in five years, and provides a counterbalance to the Fed’s reduction, analysts say.

“It’s almost fortuitous that this is happening. It’s certainly good for the Treasury market — it will help offset some of the loss in demand,” said Gennadiy Goldberg, senior US rate strategist at TD Securities.

Trading was hectic in the government debt market after the announcement, with the most movement in long-term and inflation-sensitive yields. Stocks closed at record highs.

Eurodollar futures, a much-watched measure of interest rate expectations, were pricing an increase in rates starting in the third quarter of 2022.

Translated by Luiz Roberto M. Gonçalves