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Fed signals balance-sheet wind down

As widely expected, Federal Reserve policymakers raised short-term rates for the second time this year, and also signaled the central bank would soon begin winding down its massive holdings of securities.

Following a two-day meeting, the Federal Open Market Committee raised the federal funds rate by a quarter percentage point to a target range of 1 percent to 1.25 percent. In another key move that could push longer-term mortgage rates higher, the Fed indicated that it will soon embark on a program of scaling down its $4.5 trillion in securities holdings. These were built up to unprecedented levels after the Great Recession to help stimulate the economy.

fedreserFor the time being, the Fed will continue its policy of maintaining the current level of its balance sheet by reinvesting principal payments in securities. Later this year, however, it will likely begin a gradual program of winding these holdings down. The Fed will initially allow a maximum of $6 billion per month in Treasury securities and $4 billion a month in MBS and agency debt to roll off its balance sheet. Those caps will gradually be stepped up to $30 billion per month for Treasuries and to $20 billion per month for MBS and agency debt.

Most analysts believe the Fed will eventually roll off about $2 trillion to $2.5 trillion from the current level of $4.5 trillion, a process that is expected to take several years.

During a news conference, Fed Chair Janet Yellen said the exact timing of the start of this roll-off still hasn’t been set. She said Wednesday’s announcement was meant to give the markets advance warning to avoid a repeat of the panic that occurred when the Fed announced in 2013 that it was going scale back its bond-buying program. That move brought on the so-called “taper tantrum,” which disrupted global markets and drove up interest rates for a time.

Yellen said it was her hope that this winding down of the balance sheet would have little or no measurable impact on the markets.

“This will be something that runs quietly in the background,” she said. Yellen also said that the Fed is also likely to continue a course of small incremental increases to the federal funds rate as it reduces the balance sheet.

Economists were anticipating some announcement from the Fed on its plans for its balance sheet. The markets viewed the statement as more "hawkish" than anticipated, and Treasury yields moved up slightly, said Mike Fratantoni, chief economist for the Mortgage Bankers Association. 

"The plan emphasizes that the balance sheet will be reduced in a gradual and predictable manner," Fratantoni said. "The statement also reaffirmed that the target fed funds rate is still the primary means for monetary policy action."  

Such a move could eventually put upward pressure on long-term rates, however. The 30-year fixed rate has hovered around 4 percent for much of this year.

“The primary effect of Fed actions for all homebuyers will be the very gradual edging up of interest rates as some liquidity leaves the secondary market, which will affect affordability to some extent,” said Ray Perryman, president of The Perryman Group, a Texas-based economic and financial analysis company. “If mortgage quality improves, of course, this effect could be offset by increases in private investor interest.”


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