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A Gradual and Predictable Federal Reserve

The market did not react strongly to the Federal Reserves meeting last week, even though there were some new items introduced at the meeting. The implication is that though the Federal Reserve is in uncharted waters, winding down its unprecedented combination of large purchases of bonds and near zero interest rates, markets are comfortable with its current approach, even when the Fed makes policy changes. By proceeding very gingerly and choreographing how it will end the programs instituted in response to the financial crisis, the Federal Reserve is, in general, helping keep markets calm.

Last Wednesday the Fed announced a new template for how it will return to normal policy, updating the normalization principles they created in 2011. While as before interest rates will be raised primarily by raising the federal funds rate, it introduced a new tool to help guide interest rates – reverse repurchase agreements. The Fed also changed its approach to its huge holdings of bonds, specifically the mortgage related bond portion. Sales are no longer planned, though the Fed does foresee a point where its holdings will return to more normal levels and will hold no more securities than necessary to implement monetary policy efficiently and effectively.

One of the phrases in the Fed template gradual and predictable manner is a good synopsis of the Federal Reserves recent tactics. While only time will tell when Federal Reserve actions will unnerve markets (as Ben Bernankes taper remarks did in summer 2013), currently the markets are moving in stride with Fed policy.

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