The US central bank closes the faucet

The US Central Bank (Fed) is taking an important first step towards normalizing its monetary policy. On Wednesday, it decided to cut its purchases of government bonds and regroup mortgages by $15 billion per month from November. “This means that we will be ending bond buying by the middle of next year,” Federal Reserve Chairman Jerome Powell said at a news conference.

According to the central bank, “significant progress” has been made towards its twin goals of maximizing employment and stabilizing prices. The unemployment rate fell from a peak of 14.8 percent in April of last year to 4.8 percent in September. At 4.4 percent, inflation is more than double the long-term target of 2 percent on average.

The central bank says high inflation mainly reflects factors that may be temporary. He added that “the imbalance between supply and demand caused by the epidemic and the reopening of the economy contributed to a significant increase in prices in some sectors.” The Fed expects supply issues and shortages of raw materials and parts to ease next year.

Since the beginning of the pandemic, the Fed has bought at least $4.4 trillion in debt. By doing so, the central bank has bolstered bond markets and pushed long-term interest rates lower. Reducing these purchases will reduce the demand for government bonds and possibly raise long-term interest rates.

After the widely awaited decision to cut bond purchases, the question arises of when the second step – raising short-term interest rates – will follow. Powell stressed that “reducing bond purchases is not an indication that a rate hike is imminent.” “The conditions for raising interest rates have not been met, because we have not yet reached the maximum employment opportunity.”

There are still 5 million fewer jobs in the US than there were before the pandemic began. Job creation has slowed significantly in recent months as companies fail to fill the very large number of vacancies. Millions of Americans are no longer available for the job market, because they retired early during the pandemic or fear contamination from the delta variant of the coronavirus. A tight labor market is causing wages to rise sharply, but Powell indicated he’s not too concerned about that right now.

Powell was asked if the interest rate market is wrong if it expects one or two increases over the course of the next year. He first suggested that the Fed could be “patient.” In other words, the rate hike is not for tomorrow. Later, the Fed chair let out a more glimpse of his papers. “If the current trend continues, we may reach maximum employment in the second half of next year.”

It is clear that the Fed is reducing its support for the economy faster than the European Central Bank (ECB). The European Central Bank plans to continue buying government and corporate bonds for some time to come, and committee chair Christine Lagarde stressed on Wednesday that a rate hike in 2022 is “highly unlikely”.