The Federal Reserve will bring to an end its long-running bond purchase program, according to a statement released Wednesday, concluding a stimulus exercise that has attracted intense debate as to its impact on the economy and the financial markets.
Improving market conditions, including diminished fears of persistently low inflation and a steadily descending jobless rate, led the Fed to make the call to put an end to its third round of purchases of mortgage- and treasury-backed bonds. To date, the Fed has amassed a balance sheet of $4.48 trillion since it started its quantitative easing strategy in November 2008.
The Fed plans to hold onto its securities and will reinvest principal payments from its holdings into its own agency-backed securities and will roll over maturing Treasury securities at auction. It is hoping that by holding its bond balance, it will “help maintain accommodative financial conditions” in the economy without needing to continue with new purchases.
The Fed’s policy-setting Open Market Committee made the statement at the end of its two-day meeting Wednesday. Many analysts were hoping for further insight into when the Fed may start boosting interest rates. The committee stands by its 0% to 0.25% target range for the federal-funds rate, which means that interest rates across the broader economy will remain at their consistently low levels for now.
In its statement, the Fed was remarkably upbeat about the economy’s prospects, saying that since the Federal Open Market Committee last met in September, “labor market conditions have “improved somewhat further, with solid job gains and a lower unemployment rate.”
“On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing,” the statement said.
Whether or not the economy’s gains can be attributed to the Fed’s quantitative easing program is a matter of debate. Since its inception, the unemployment rate has fallen to 5.9% last month from a high of 10% in October 2009, a year after the bond-buying began. Meanwhile, U.S. gross domestic product is expected to pick up to 2.8% this year, according to the International Monetary Fund, compared to 0.3% decline in 2008.
“We’re better off from an investment and economic perspective without QE than if it had continued, even if there is short-term volatility,” said Liz Ann Sonders, chief investment strategist at Charles Schwab. “We can at least see if the economy can operate under its own engine power, and we will probably see the stock market behave more in-line with earnings rather than gyrating around QE.”
Sonders said that unlike the first and second rounds of quantitative easing, the third round put downward pressure on confidence.
“The bigger the balance sheet, the harder to exit,” she said, referring to the growth in the Fed’s balance sheet due to its unprecedented asset-purchase program.
The Fed still doesn’t have to face the prospect of exiting its investments just yet, and has said it won’t change its balance sheet until at least the committee begins raising interest rates again. Even so, there may be some volatility in the markets following the end of QE3, much like after the end of the first two programs.
Following the end of QE1, there was a 17% correction in stocks, leading the Fed to launch its second generation of the program. Then, after the wind-down of QE2, there was a 20% stock market correction, and the Fed once again chimed in with a third — and what they say will be final — round of QE.
Some of that volatility happened in advance this time around, as evidenced by the fluctuations that rocked the markets over the past two weeks. A short-term correction and plunge in yields is fairly common, and could continue.
The recent rocky markets haven’t yet worried the Fed, but if the market volatility becomes more severe the committee may decide to adjust its course, similar to its actions following QE1 and QE2.
“That will be an interesting test for the Fed,” said Sonders. “Will they adjust monetary policy or their language given the volatility, even without a deterioration in their dual mandate?”
Read more on the Fed’s exit from QE in Chris Matthews’ article Are we really saying goodbye to QE forever?