Fed Targets October for Wind-Down of Mortgage-Backed Asset Purchases

For once, the question ahead of the Federal Open Market Committee’s regular policy meeting wasn’t about raising the federal funds rate. Instead, it focused on when it would formally begin winding down its purchases of mortgage-backed assets (the answer: October).

Unwinding the Fed’s $4.5 trillion mortgage asset purchase program, devised to stabilize the economy following the Great Recession, will begin next month. Characteristically, the Fed referred to it as a “balance sheet normalization program.”

The FOMC also indicated it will likely continue to incrementally raise the federal funds rate, currently at 1.25-1.50 percent. The Fed is widely expected to raise the rate by another quarter-point at its December meeting and indicated it could raise the rate as many as three times in 2018.

“For much of the past decade, the Fed has been the largest investor in mortgages in the world,” said Mortgage Bankers Association Chief Economist Mike Fratantoni. “The Fed took the first step today to begin to shrink their holdings. We expect that private investors will, over time, step in to buy MBS. But we can’t be certain how quickly they will replace the steady demand that the Fed has been providing.”

Fratantoni said the balance sheet reduction is not likely to have a large impact immediately, “as its beginning was very well telegraphed. As the pace of reductions increases through 2018, we expect a larger impact on rates, and the potential for additional rate volatility,” he said. “In her post-statement press conference, Chair [Janet] Yellen made it clear that the hurdle to changing plans with respect to the balance sheet is high.”

Overall, Fratantoni said, the Fed’s statement was “relatively hawkish, with members clearly indicating plans to increase short-term rates one more time this year, likely in December, and 3-4 times per year until the fed funds target reaches roughly 3 percent. Even though inflation remains relatively low, the tight job market is leading the Fed to slowly move rates up to prevent the economy from overheating.”

The full FOMC statement appears below; paragraph breaks were added for clarity:

“Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have remained solid in recent months, and the unemployment rate has stayed low. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. On a 12-month basis, overall inflation and the measure excluding food and energy prices have declined this year and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Hurricanes Harvey, Irma, and Maria have devastated many communities, inflicting severe hardship. Storm-related disruptions and rebuilding will affect economic activity in the near term, but past experience suggests that the storms are unlikely to materially alter the course of the national economy over the medium term.

“Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace, and labor market conditions will strengthen somewhat further. Higher prices for gasoline and some other items in the aftermath of the hurricanes will likely boost inflation temporarily; apart from that effect, inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

“In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 1 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to 2 percent inflation.

“In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal.

“The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

“In October, the Committee will initiate the balance sheet normalization program described in the June 2017 Addendum to the Committee’s Policy Normalization Principles and Plans.

“Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; Neel Kashkari; and Jerome H. Powell.”