Next month the Federal Reserve will start to run down the stock of bonds which it bought under the quantitative easing (QE) programme as Janet Yellen signals the end of the scheme to pump more money into the US economy.
Interest rates are also set to rise further in the coming months as the US economy adapts to a higher pace of growth, allowing rate hikes to move the Fed further away from its emergency policy position.
“The labor market has continued to strengthen and that economic activity has been rising moderately so far this year,” said the Federal Open Markets Committee, justifying its decision to tighten monetary policy.
“Job gains have remained solid in recent months, and the unemployment rate has stayed low. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters.”
More than $4.5 trillion (£3.3 trillion) of bonds have been bought, with the policy being used to combat the credit crunch from late 2008 onwards under the plan to lower interest rates and stimulate the economy.
Until now, the Fed has reinvested the money released when the bonds matured.
But now Ms Yellen will only reinvest part of those funds, gradually increasing the amount which is redeemed and not reinvested.
At first the Fed will allow $6bn of maturities of government bonds per month and reinvest any bond payouts above that level. The monthly rate will rise in increments of $6bn at three-month intervals until it hits $30bn per month.
It will do the same with its stock of mortgage backed securities, with a cap of $4bn per month initially, rising to $20bn per month.
The Fed is not yet actively selling its stock of bonds.
This move was carefully flagged up by the Fed in recent months in a bid to ensure the market takes the decision calmly.
In 2013 the so-called ‘taper tantrum’ shook world markets when the Fed said it was looking at slowing the pace of bond buying, driving up the dollar and causing turmoil in emerging markets.
Inflation remains below 2pc which may limit the Fed’s appetite for higher rates, and analysts note that it is not yet known has the new policy on QE will affect growth.
“The Fed’s announcement today to start unwinding the balance sheet has already been priced in by markets, but we continue to believe the Fed's ‘quantitative tightening’ could be the cause of some heightened volatility, especially as the impact on the real economy remains largely unknown,” said Kully Samra, UK managing director of Charles Schwab.
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