The Federal Reserve announced Wednesday its first step toward paring back the support for financial markets it has deployed since the emergence of the COVID-19 pandemic roiled the economy last year.
The Federal Open Market Committee (FOMC), which sets Fed monetary policy, announced it would begin to reduce its monthly purchases of Treasury bonds and mortgage-backed securities by $15 billion each month starting in November. The bank had been purchasing at least $80 billion in Treasuries and $40 billion in mortgage bonds since March 2020 and will be on pace to end those purchases by June at the pace announced Wednesday.
The FOMC announced it will purchase roughly $70 billion in Treasury bonds and $35 billion in mortgage bonds in November, a reduction of $10 billion and $5 billion, respectively, of each. The bank will continue to reduce those purchases at that rate barring a significant shift in financial markets, it said.
The Fed will also maintain its baseline interest rate range between zero to 0.25 percent, the level set in March 2020 as markets began to crash at the outset of the pandemic.
"It is time to taper we think because the economy has achieved substantial further progress toward our goals measured from last December," Fed Chairman Jerome Powell told reporters in a press conference following the announcement.
"We don't think it's time yet to raise interest rates. There is still ground to cover to reach maximum employment, both in terms of unemployment, in terms of participation."
The Fed’s announcement followed months of escalating hints and signals from FOMC members that the bank would begin to taper before the end of the year. The bank has purchased trillions of dollars in Treasuries and mortgage bonds since the outset of the crisis and now holds a record $8.5 trillion in such securities on its balance sheet.
Fed bond purchases have the effect of reducing borrowing costs and stimulating financial markets further when the bank had already cut its baseline interest rate range to zero to 0.25 percent. The process is intended to flood markets with cheap cash at the outset of the crisis, slowly turn off the nozzle as the economy recovers and eventually sell off those bonds once markets stabilize.
As inflation continued to rise this year amid supply chain snarls and hiring troubles, the Fed faced growing pressure to taper — and even suspend its bond purchases entirely.
Both U.S. gross domestic product and the stock market have recovered the entirety of their pandemic losses, the country has recovered nearly 75 percent of the jobs lost to COVID-19 and price increases have run higher and longer than many Fed officials expected.
"Inflation is elevated, largely reflecting factors that are expected to be transitory. Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors," the FOMC said.
Even so, an abrupt change in course would likely rattle markets and raise questions about the Fed’s confidence in its handling of inflation.
Powell also stressed the importance of gradually easing out of a stimulating monetary policy while COVID-19 and pandemic-related constraints are still limiting the recovery.
"We understand the difficulties that high inflation poses for individuals and families, particularly those with limited means to absorb higher prices for essentials, such as food and transportation," Powell said Wednesday.
"Our tools cannot ease supply constraints. Like most forecasters, we continue to believe that our dynamic economy will adjust to the supply and demand imbalances," he continued. "Global supply chains are complex. They will return to normal function, but the timing of that is highly uncertain."
The personal consumption expenditures (PCE) price index, the Fed’s preferred gauge of inflation, rose 4.4 percent in the year leading into September, according to data released last week. While annual inflation rose from 4.2 percent in August, the monthly increase in the PCE price index stayed flat at 0.3 percent and declined to 0.2 percent when stripping out food and energy prices.
The Fed is not expected to hike interest rates until the conclusion of its tapering process and has set a much higher standard for raising borrowing costs than paring back bond purchases.
Powell has said that the Fed won’t hike rates until the labor market has reached full employment, but has not laid out specific conditions that will warrant rate increases. Most Fed officials don’t expect to hike until the second half of 2022, though some have openly suggested the bank could be forced to raise rates quicker if high inflation persists.
If the Fed is forced to hike rates earlier than expected, the move could pose serious questions about the durability of a new approach to inflation it adopted last year.
Inflation had run well below the Fed's 2 percent annual target for more than a decade leading into the pandemic, due in part to the Fed's insistence on hiking rates before inflation actually reached that target. Many economists say those decisions were among several factors that slowed the recovery from the Great Recession and caused employment to linger below its ideal level.
Under Powell, the Fed cemented a new strategy that called for allowing inflation to run above its target for long enough to make up for low inflation, but not spur a dangerous cycle of price and wage increases.
Republican lawmakers, some moderate Democrats and inflation-wary investors have urged the Fed to shift course as inflation runs well above its target for longer than the bank expected. Those worried about the Fed's approach insist that the bank could force price and wage increases to rise rapidly, as they did during the late 1970s, and force a punishing series of rate hikes.
Even so, Powell expressed confidence that current inflationary pressures did not reflect a long-term limit on the economy's ability to catch up to demand, but the persistence of pandemic-related limits on supply.
"As we try to think about what maximum employment would be, we're going to have to see some time post-COVID, or post-delta [variant] anyway, to see what is possible," Powell said.
"We know that we were on a path to a different place, as I mentioned, when delta arrived, and delta stopped job creation," he continued. "We want to see that healthy process unfold as we decide what the true state of the economy is, and we think it will evolve in a way that will mean lower inflation."
Updated at 3:03 p.m.