WASHINGTON (AP) — It will come as no surprise if the Federal Reserve has an announcement to make when its latest policy meeting ends Wednesday: That it’s ready to begin paring its enormous $4.5 trillion portfolio containing Treasurys and mortgage bonds.
The Fed expanded its bond holdings — the major assets on its balance sheet — in the years after the financial crisis erupted in 2008. It bought the bonds to try to hold down mortgage and other loan rates and support a fragile economy. The Fed stopped buying new bonds in 2014 but kept its balance sheet high by reinvesting the proceeds of maturing bonds.
Now, with a much stronger economy, Fed officials are expected to announce a starting date to begin allowing the bond holdings to shrink gradually. No one is quite sure how the financial markets will respond over time.
One thing not expected Wednesday is any change in the Fed’s key policy rate, which remains in a low range of 1 percent to 1.25 percent. The central bank may signal how likely a rate hike is by December, when some analysts foresee the next increase.
Here are three things to watch for after the Fed’s meeting ends:
REDUCING THE BALANCE SHEET
Just as the Fed had never before engaged in a bond-buying spree of such magnitude, it has never attempted to shrink a portfolio that is now roughly five times its size before the financial crisis.
Under the plan the Fed announced in June, it will start to allow a slight $10 billion in holdings to roll off the balance sheet each month — $6 billion in Treasurys and $4 billion in mortgage bonds. That figure would inch up by $10 billion each quarter until it reaches $50 billion in monthly reductions a year from now. At this rate, the Fed’s balance sheet would still be above $3 trillion by late 2019.
Those sales are expected to exert modest upward pressure on long-term rates, like mortgages. The Fed has given investors months to digest its forthcoming move and has stressed that the paring of its balance sheet will proceed extremely gradually. Still, the risk exists that investors could become spooked by the rising number of bonds being transferred back into private hands. If that were to happen, long-term rates might surge undesirably high, which could weigh on the economy.
Any damage in the markets could also extend to assets such as stocks, which have set record highs as investors have shifted money into stocks and away from low-interest bonds. There is also concern that rates could climb faster if other central banks follow the Fed’s lead and begin reducing their own bond holdings.
STATE OF ECONOMY
The Fed will update its economic forecasts, which are compiled from the projections of its board members and the 12 regional Fed bank presidents. The projection for unemployment will show that the central bank has achieved its 4.6 percent target for full employment: The jobless rate is at 4.4 percent, near a 16-year low.
But the central bank has been going backward in trying to meet its other mandate of stabilizing prices at an annual inflation rate of 2 percent over time. Inflation has stalled, and prices are now rising just 1.4 percent annually. A critical question is whether the Fed has grown troubled or confused about chronically low inflation. Clues to the answer might come in the policy statement the Fed will issue, in its updated economic forecasts or in the news conference Chair Janet Yellen will hold.
Yellen earlier this year blamed temporary factors, such as the introduction of cheaper mobile phone plans, for the persistence of undesirably low inflation. More recently, she has wondered whether something more widespread might be keeping inflation low. If the Fed were to coalesce around that belief, doubts could arise about whether it should keep raising rates or delay further hikes.
Hints of whether the Fed will likely raise rates in December for a third time this year could come from its revised “dot plot,” in which individual Fed officials anonymously post their expectations for future rate hikes. The June “dot plot” had pointed to three rate increases for 2017.
MAKEUP OF THE FED
Beyond her own views on the economy, inflation and the Fed’s balance sheet, Yellen might decide to drop a hint in her news conference about an even more tantalizing topic: Her own future. She will certainly be asked. Yellen’s four-year term as chair will end on Feb. 3.
President Donald Trump has indicated that he is considering asking Yellen to serve another term. He said of the Fed chair last week, “I like her, and I respect her.” But he has also said he is considering other candidates, notably Gary Cohn, head of Trump’s National Economic Council.
When asked about her future, Yellen, the first woman to lead the Fed, has said only that she intends to serve out her term as chair. She has not indicated whether she would or wouldn’t accept a Trump offer to serve another term.
The seven-member Fed board will soon have four openings, after the announcement this month by Stanley Fischer that he is stepping down as vice chairman. So far, Trump has moved to fill only one spot, nominating Randal Quarles, who has yet to be confirmed by the Senate, to the key post of vice chairman for bank supervision.
Many Fed watchers have expressed their belief that Yellen has performed well and deserves a second term as chair.
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