Fed to draw down investment in bonds, leaves rates unchanged

Fed Reserve building shutterstock.jpg

The Federal Reserve will begin winding down its investment in government bonds that it acquired following the financial market collapse that triggered the Great Recession. The Fed announced today that it will allow $10 billion of Treasury and mortgage-backed securities to mature each month without buying new ones as it cautiously approaches the wind down to avoid another financial collapse.

Just as importantly, Chairwoman Janet Yellen said the Fed is not changing its short-term interest rate target, which has one additional increase slated for this year and three increases set for 2018.

The Fed announced that it will start to wind down its $4.5 trillion portfolio. The portfolio is an accumulation of government bonds and mortgage-backed securities the Fed has been acquiring since the Great Recession. Commonly known as “quantitative easing,” the idea behind the purchasing was to promote economic growth by helping keep long-term interest rates low. In 2008, the Fed’s portfolio was about $900 billion, but had grown to $2 trillion a year later.

The Fed has not been buying any assets since 2014, reports Bloomberg, but it has also not been selling them either. By purchasing these bonds and securities, the Fed helped government finance budget deficits through lower rates, but it also made it cheaper for things like homes and vehicles, including truck equipment purchases.

“It also had important implications for financial markets. The Fed’s purchases made U.S. Treasury securities more expensive, thus encouraging investors to buy stocks instead,” Bloomberg explained.

According to Bloomberg, when the Fed suggested it would curtail its buying in 2013, it led to a rise in long-term interest rates that hurt housing and emerging markets. But, some officials worry that the Fed is influencing financial markets and as a result, some investors are taking on riskier bets. There may be a political reason as well, Bloomberg suggested.

“Republican lawmakers were sharply critical of the Fed’s quantitative easing programs, charging that the central bank was making it easier for President Barack Obama to run big budget deficits. By reducing the balance sheet, Fed insiders are hoping to defuse some of that criticism and protect the central bank’s political independence,” the news organization said.

There was no announcement on when the shrinking of the portfolio would end, but the Associated Press reported that Federal Reserve Bank of New York President William Dudley said it would fall to between $2.4 trillion and $3.5 trillion sometime in the early 2020s.

In addition to indicating no change to its rate outlook, which should give transportation planners some certainty as they prepare 2018 capital budgets, the Fed is now expecting real GDP to grow between 2.2% and 2.5% this year. That is up from a range of 2.1% to 2.2% noted in June, indicating continued strength in the economy.

In keeping its short-term federal funds rate between 1% and 1.25%, the Fed noted a mix of economic indicators, including an unemployment rate of 4.4% in August but a less-than-expected 156,000 new jobs added, and inflation readings that are below the Fed’s 2% target.

The Personal Consumption Expenditures Index fell to 1.4% in July, its lowest level in months, and the Consumer Price Index only grew slightly to 1.9% in August.

“Higher prices for gasoline and some other items in the aftermath of the hurricanes will likely boost inflation temporarily; apart from that effect, inflation on a 12-month basis is expected to remain somewhat below 2% in the near term but to stabilize around the Committee’s 2% objective over the medium term,” the bank said.

“Job gains have remained solid in recent months, and the unemployment rate has stayed low,” the Fed added. “Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters.”

There is still a one-quarter point forecasted rate hike set for later this year and three for next year as the Fed looks to boost the rate to 2.9% by 2020. The slow rise in interest rates remains good news for transportation as the rate influences the rates banks charge customers for borrowing money for everything from equipment purchases to operating lines of credit.

Continued growth in the economy is even better news, as freight volumes should continue to rise as the holiday season approaches and capacity grows tighter, driving up shipping rates.