WASHINGTON (MarketWatch) — The Federal Reserve on Wednesday said it will start to reduce its massive $4.5 trillion pile of government and mortgage debt “relatively soon,” a long-expected move that reflects the central bank’s optimism in a steadily growing U.S. economy.
In May the Fed said it would begin to wind down its balance sheet later “this year.” The latest statement points to the central bank either announcing or launching the effort by September.
“This is a clear signal that the Fed will start unwinding its gargantuan balance sheet in September,” said Luke Hickmore, senior investment manager at Aberdeen Asset Management.
The bank aims to whittle down its collection of bonds over the next several years, though the Fed said it’s unlikely to restore its balance sheet to pre-recession levels of around $800 billion.
As expected, the Fed also left a key U.S. interest rate unchanged.
Most of the Fed’s official statement in July was little changed from its last meeting in June, but the bank did offer a note of caution on inflation.
The Fed said inflation was “running below 2%” instead of “running somewhat below 2%,” as it did in the June statement. The Fed’s preferred inflation gauge, the PCE index, has tapered off to 1.4% growth over 12 months from a five-year high of 2.1%.
The central bank thinks the economy is strong enough to get by on its own after eight years of expansion, but senior officials want to see the annual pace of inflation return to 2%.
Fed Chairwoman Janet Yellen initially blamed temporary factors such as a spike in the cost of wireless-phone plans, but she seemed less sure in testimony before Congress last month.
Other senior Fed officials are even more leery about the slowdown in inflation. Some have urged greater caution in raising rates, especially as the bank launches its balance-sheet drawdown.
The central bank helps set the cost of loans to businesses and consumers via a short-term rate known as fed funds that’s now set between 1% and 1.25%.
The Fed has already raised the cost of borrowing twice in 2017 and it’s pegged in one more increase before the end of the year, most likely in December, analysts predict. Wall Street investors see little likelihood of an increase when the Fed meets in September or November.
The Fed had kept the rate near zero for years after the 2007-2009 recession to stoke U.S. growth. It only started raising rates two years ago.
Reducing its huge balance sheet could be a lot trickier. The Fed bought a bounty of Treasurys and mortgage-related bonds during and after the Great Recession to help drive down U.S. interest rates and prop up a battered economy.
The bank aims to sell off its balance sheet piecemeal in an effort to avoid any surprises that roil Wall Street and potentially harms growth. That’s what happened in 2013 during the so-called “taper tantrum.”
So far the approach seems to have worked. The Dow Jones Industrial Average
, for instance, has climbed 9% in 2017 despite the Fed rate hikes.