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Fed Could Start Tapering QE3 By End Of Year
MADISON, Wis., and WASHINGTON (6/20/13)--The Federal Reserve could begin tapering off its bond-purchasing program later this year, said Fed Chairman Ben Bernanke Wednesday after the Federal Open Market Committee (FOMC) meeting. That set off a flurry of bond buying after the meeting. But for now, the Fed's monetary policymakers are holding steady on any action and keeping their near-zero targeted federal funds interest rate.

"In a much anticipated FOMC statement and Bernanke press conference, the bond market sold off due to expectation that the Fed will begin tapering its asset purchase program later this year and end the program in the middle of 2014 when the unemployment rate falls to 7%," said Credit Union National Association Senior Economist Steve Rick.

"This will increase Treasury yields and reduce bond prices," he told News Now Wednesday. "In anticipation of this policy change, investors' demand for longer-term bonds has been declining, pushing up interest rates. After reaching a low of 1.66% on May 1, the 10-year Treasury interest rate rose over 0.5 percentage points in little over a month to reach 2.22% on June 10.  The 10-year Treasury interest rate rose 12 basis points in the hour and a half after the announcement, rising from 2.21% to 2.33%."

So where are long-term interest rates headed?  "We expect the 10-year Treasury interest rate to continue to rise to 2.4% by the end of 2013 and 2.7% by the end of 2014 as real interest rates rise faster than expected inflation falls," Rick said. "This will steepen the yield curve and therefore reduce the margin compression financial institutions have been experiencing over the last several years."

However, "on the downside, the mortgage refinance boom credit unions have experienced over the last two years will come to an end," Rick said.  "This will reduce earnings as credit unions see less mortgage origination fees and less 'gains of sale of mortgage' income," he concluded.

The FOMC met Tuesday and today. Saying that "economic activity has been expanding at a moderate pace," the committee in its statement after the meeting indicated that the holding pattern on its quantitative easing policy--its $85 billion-a-month bond asset purchase plan and the targeted interest rate of 0% to 0.25%--would continue. In Bernanke's press conference, he indicated the Fed could begin to taper its bond purchases later this year, if its forecasts for inflation and unemployment are correct (MarketWatch June. 19).

Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated," said the committee's statement. "Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the committee's longer-run objective, but longer-term inflation expectations have remained stable."

The committee noted it "expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the committee judges consistent with its dual mandate" of fostering maximum employment and price stability. It  also "sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The committee also anticipates that inflation over the medium term likely will run at or below its 2% objective," said the statement.

The committee "decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month" and it will maintain its existing policy of "reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative," said FOMC.

It will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability, said the FOMC.

"The committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives."

The FOMC also said its "highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens." It keptthe target range for the federal funds rate at 0% to 0.25% "and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the committee's 2% longer-run goal, and longer-term inflation expectations continue to be well anchored."

In determining how long to maintain a highly accommodative stance of monetary policy, the committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When it decides to begin to remove policy accommodation, it will take "a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2%."

Voting for the  action were: Federal Reserve Chairman Ben S. Bernanke; Vice Chairman William C. Dudley;  Elizabeth A. Duke; Charles L. Evans; Jerome H. Powell; Sarah Bloom Raskin; Eric S. Rosengren; Jeremy C. Stein; Daniel K. Tarullo; and Janet L. Yellen.

Voting against the policy action were James Bullard, who said the committee should signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings, and Esther L. George, who was concerned the continued high level of monetary accommodation increased the risks of future economic and financial imbalances and, over time, could cause an increase in long-term inflation expectations.
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