Inside Fed, what to tell markets a nagging question

The Federal Reserve (J.M. Eddins, Jr./MCT)
The Federal Reserve (J.M. Eddins, Jr./MCT) MCT

The Federal Reserve is still months away from ending its controversial purchase of bonds to stimulate the economy, but minutes released Wednesday for the July monetary-policy meeting show growing concern about how to communicate Fed goals with financial markets.

The purchase of trillions of dollars of government and mortgage bonds has made some investors nervous that the bond buying was akin to printing money and will eventually spark hard-to-control inflation. Financial markets, for now, are more worried about where prices for stocks and bonds settle once the Fed’s stimulus ends.

Fed governors, the minutes from the July 29-30 meeting showed, worry about how they properly communicate next steps in monetary policy once the bond-buying ends in October. Once the purchases end, the Fed can revert back to trying to influence the economy through the traditional method of its benchmark federal funds rate.

There was general agreement that the Fed is likely for some time to keep that rate at a .25 percent, sometimes referred to as 25 basis points. The fed funds rate reflects what banks ideally charge each other for overnight lending, and it serves as a reference for commercial banks when they set the prime rate charged to their healthiest borrowers.

Where members of rate-setting Federal Open Market Committee did not completely agree is whether the fed funds rate is the only tool with which to conduct monetary policy. Some members felt that in keeping rates low well into the future, the Fed can effectively conduct monetary policy also through the rate of interest on excess reserves that banks park at the Fed. Lower interest paid by the Fed would encourage banks to seek a higher profit through investment or lending.

Other members, however, felt this approach ultimately would prove confusing to financial-market participants.

There was also a question of what do with all those bonds already purchased.

“Participants also discussed approaches to normalizing the size and composition of the Federal Reserve’s balance sheet,” the minutes said. “In general, they agreed that the size of the balance sheet should be reduced gradually and predictably.”

That discussion underscored what an unusual period the U.S. economy has traversed since the financial crisis and Great Recession began in late 2007. Even after the Fed stops buying bonds, it will have billions of dollars of securities on its books and must decide whether to sell them back into the market or let them expire upon maturity. The Fed must also decide when and how quickly it will stop reinvesting the profits of its bond holdings.

On the economy, the minutes noted that participants said improvement in the labor market over the past year “had been greater than anticipated and that labor market conditions had moved noticeably closer to those viewed as normal in the longer run.”

The state of the labor market and monetary policy are expected to be topics of discussion in Jackson Hole, Wyoming, where Fed Chief Janet Yellen and central bankers from across the globe meet beginning Thursday at an annual summer retreat.