Fed to Taper Monthly Bond Purchases, Economic Stimulus in 2014

The Federal Reserve will begin tapering its monthly bond purchases to $75 billion starting next year, following an announcement today from the Federal Open Markets Committee (FOMC).

Beginning in January, the FOMC will add to its holdings of agency-backed securities at a pace of $35 billion per month, rather than $40 billion per month. The agency will also add to its holdings of longer-term Treasury securities at a pace of $40 billion per month, rather than $45 billion.

The Committee said it is also maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities, while also maintaining its policy of rolling over maturing Treasury securities at auction.

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Despite the changes announced today to reduce its monthly bond purchases from $85 billion to $75 billion, FOMC believes its holdings of longer-term securities will help bolster a stronger economic recovery.

“The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate,” FOMC stated in a release.

Mortgage market participants, however, expect the paring down of economic stimulus to lead to higher interest rates in the coming year.

“We anticipate interest rates to continue to go higher as the economy improves in 2014 which will help solidify the attractive extension protection story for HMBS,” said Darren Stumberger, managing director of mortgage trading at Stifel.

FOMC also reaffirmed today the current low target range for the federal funds rate of 0 to 0.25% will be appropriate as long as the unemployment rate remains above 6.5%, among other factors, including the projected inflation rate one and two years ahead being no more than half a percent above the Committee’s 2% longer-run goal.

Based on the assessment of these factors, FOMC anticipates that it will be appropriate to maintain the current target range for the federal funds rate well-past the time that the unemployment rate declines below 6.5%.

“When the Committee 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%,” FOMC stated in the release.

Written by Jason Oliva

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