The Federal Reserve is edging closer to unwinding some of the ultra-easy policy measures put in place during the COVID-19 pandemic in order to keep the U.S. economy afloat amid an unexpectedly large spike in inflation.
During their June policy-setting meeting, policymakers at the U.S. central bank unanimously voted to hold the benchmark federal funds rate at a range between 0% and 0.25%, where it has been since March 2020, and to keep purchasing $120 billion in bonds each month, a policy known as "quantitative easing" that's designed to keep credit cheap.
In its post-meeting statement, the Fed committed to maintaining support for the economy until "inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time" and "labor markets have reached levels consistent with the committee's assessment of maximum employment."
But policymakers also took an unexpectedly hawkish turn, forecasting two interest rate hikes in 2023 as they raised headline inflation expectations to 3.4% for 2021 – a full point higher than the March forecast. Still, Fed officials gave no signs they were considering immediately scaling back the aggressive bond-buying program.
Chairman Jerome Powell told reporters during the post-meeting press conference that officials had started "talking about talking about" tapering.
"I expect that we'll be able to say more about timing as we see more data, basically," he said. "There's not a lot more light I can shed on that." He said the Fed would give markets plenty of advance notice before it begins to withdraw the support that began last year.
Wall Street widely expects the Fed to provide more insight into the timing of tapering when central bankers gather in August at their annual retreat in Jackson Hole, Wyoming.
"If the U.S. economic recovery continues to accelerate to a sufficiently robust level into the summer, the Fed is expected to signal rolling back its asset purchases later this year," said Mark Haefele, UBS Global Wealth Management's CIO. "But the actual tapering would only take place in 2022, and we believe markets have largely priced in this expectation."
The central bank deployed quantitative easing in March 2020, restarting large-scale purchases in order to bolster the financial market. The theory is that by making such large-scale purchases, the Fed creates increased demand for those securities, which in turn raises their prices. As prices increase, interest rates fall — essentially ensuring that rates for mortgages and car loans remain low, keeping major purchases possible for American consumers and businesses.
The Fed purchases securities on the open market; when it buys Treasurys, it pays the government its value, flushing the financial system with cash. When that happens, more money is available to banks; interest rates tend to be lower and people are more likely to borrow money and spend.
Quantitative easing first began in 2008, during the Great Recession. At the time, the Fed had about $870 billion on its balance sheet. By 2014, the amount had surged to about $4.5 trillion. As of June 30, the Fed's balance sheet expanded to a record $8 trillion.
In reducing the size of their bond-buying program, Fed officials are wary of repeating the "taper tantrum" of 2013, when then-Chair Ben Bernanke's mere suggestion of such a move triggered a spike in bond yields, causing big losses for their holders.
Dallas Fed President Robert Kaplan said last week that the Fed's tapering program – which he hopes will begin "soon" – will run smoother this time because investors are aware that such a move is being discussed publicly.
"I want it to get out into the market, and I think this debate we’re having at the FOMC, some of it publicly, is good," Kaplan said during an interview with Bloomberg Television. "People are on notice that these adjustments are coming, the only question is when."