The FOMC Tapers, But That's Not All!
In a move that has been discussed and anticipated for months, the Federal Reserve's Federal Open Market Committee announced that it would slightly scale back its current quantitative easing program (QE3). Specifically, it would slow its purchases of longer-term Treasury and mortgage-backed securities by $5 billion per month each, reducing the total monthly purchase from $85 billion to $75 billion. It also announced a change in its policy towards the federal funds rate.
Market reaction was generally positive following the statement, possibly seeing the scaling back of QE3 as a sign that the Fed sees improvement in the economy or reacting to the fed funds rate announcement that is described below. This was in contrast to a market slide earlier this year reacting on rumors of a tapering of QE3.
Note that while this move would represent less accomodative policy, it would not mean that the Fed balance sheet would shrink in absolute terms, just that it would not grow as fast. The Fed's $1.8 trillion holdings in longer-term securities and $1.5 trillion holdings in mortgage-backed securities will continue to grow in nominal dollars, as will the balance sheet overall, which currently sits at close to $4 trillion. The graph below shows how the balance sheet has changed and grown since the recession.
Source: Cleveland Federal Reserve
Another interesting statement came regarding the federal funds rate, which is near zero. In October 2012, the FOMC said that the low federal funds rate would likely be warranted through 2015. They changed the statement in December of that year to say that the rate would be kept there until the unemployment rate fell below at least 6.5 percent and inflation rose above 2.5 percent, with the caveats that these were not immediate triggering thresholds and that other economic conditions would be taken into account. Apparently, the FOMC was convinced that the state of the other conditions' warranted keeping the fed funds rate near zero "well past the time that the unemployment rate declines below 6-1/2 percent."
So while many people may report this as an "unwinding" of the Fed's loose monetary policy, it is actually trading a reduction in the purchases of QE3 in exchange for an explicit lengthening of amount of time when the fed funds rate will be near zero.