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Fed quietly opens the final chapter of its crisis-era bonds policy

EconomySep 20, 2017 07:00PM ET
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© Reuters. The Federal Reserve Building in Washington

By Jonathan Spicer

NEW YORK (Reuters) - The Federal Reserve, the world's largest holder of U.S. debt, announced on Wednesday it was edging back from the market and investors barely budged.

There were no tectonic shifts in stock, bond or currency markets after the U.S. central bank said not only that it would begin trimming its $4.5-trillion portfolio of assets next month, but that it was sticking with plans to hike interest rates this year despite the markets' skepticism.

Months of telegraphing by the central bank allowed for the muted market response seen on Wednesday. Yet the Fed's decision to begin winding down one of its most controversial policies of the crisis era, which attracted sharp criticism from congressional conservatives and economic purists over the last decade, amounted to a bold bet on the U.S. economy's prospects.

The Fed, under Chair Janet Yellen, has set its own pace and agenda. Under Yellen, who took office in 2014, it has raised interest rates four times from near-zero, ended its bond buying program, and now set a path to reducing its huge holdings.

"The Fed's balance sheet will finally be turning a corner," said Brian Jacobsen, senior investment strategist at Wells Fargo (NYSE:WFC) Asset Management in Menomonee Falls, Wisconsin. In New York, JPMorgan (NYSE:JPM) chief U.S. economist Michael Feroli called it an "historic move."

(For a full interactive graphic of the effects of Fed bond-buying on the economy and markets, see:

In late 2015 the central bank hiked rates for the first time since the 2007-2009 financial crisis and recession. It has followed up with three more policy tightenings over the last 10 months.

Its cautious confidence reflected steady economic growth in the face of bouts of overseas weakness, and a U.S. unemployment rate whose drop has been nearly uninterrupted over the last seven years to 4.4 percent last month.

Over the last decade, the Fed headed into unknown policy terrain as it snapped up some $3.6 trillion in mortgage and Treasury bonds in an effort to spur riskier investing and economic growth. In response financial markets sizzled, with equities logging a string of records and bond yields dipping lower than ever before.

But as direct results of the bond buying were harder to find in the real economy, critics grew louder. They warned that the Fed, in stimulating the housing sector, had overstepped its remit and that it was inflating dangerous asset bubbles that could cause the next crisis.

Yet Yellen and her predecessor, Ben Bernanke, have largely brushed off those concerns with a gradual and sometimes halting march to a more normal policy stance.

Based on its Wednesday announcement, the central bank expects to raise rates one more time this year, three times in 2018, and a gradual reduction in bonds that shrinks its portfolio down to $3 trillion by 2021.

In response, futures traders raised the odds of a December rate hike to 72 percent from 52 percent earlier in the day, while a Reuters poll found that Wall Street's top banks also backed that timeline. U.S. stock market indexes, meanwhile, closed the day mostly flat.

"Markets will have to get accustomed to the fact that the Fed actually sees through its rate-hike plans in the face of market expectations which signaled otherwise," Commerzbank (DE:CBKG) economists wrote in a note.

"Thus, unless there is a new economic shock, market expectations will have to adjust to the Fed's thinking."

(For a graphic on the legacy of the QE era, click

Fed quietly opens the final chapter of its crisis-era bonds policy

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