Can the Fed’s New Magic Tool Bring Market Stability?
“As you are aware,” Federal Reserve Bank of New York President William Dudley said in a speech at the Fordham University Graduate School of Business on Monday, “at last week’s FOMC meeting we made no changes to our monetary policy. In particular, the Committee decided to continue to purchase long-term Treasury securities and agency mortgage-backed securities at a monthly pace of $45 billion and $40 billion, respectively.”
The news, announced on September 18 at the conclusion of a two-day policy meeting, came as a surprise to the markets. In the weeks heading into the meeting, many economists and traders had settled on the idea that the Fed would decide to taper assets purchases at least a little bit — estimates generally came in a range between $5 billion and $15 billion per month — and the markets began to price in such a policy change. Interest rates climbed a full percentage point between May and September, and equities experienced two fairly violent “taper tantrums,” one in June and one in August.
But the stimulus can’t last forever, and markets are constantly on the lookout for signs of when tapering will begin and what the wind-down of Fed assets will look like. The various iterations of quantitative easing have contributed to a dramatic expansion of the Fed’s balance sheet over the past few years. As of the second week of September, total assets held by the Fed exceeded $3.6 trillion, substantially above the $869 billion level maintained before the financial crisis.