Federal Reserve Announces Plan to Slow Bond Buying Program

The Federal Reserve on Wednesday took its first step toward withdrawing support for the American economy, saying that it would begin to wind down a stimulus program that’s been in place since early in the pandemic as the economy heals and prices climb at an uncomfortably rapid pace.

Central bank policymakers struck a slightly more wary tone about inflation, which has jumped this year amid booming consumer demand for goods and supply snarls. While officials still expect quick cost increases to fade, how quickly that will happen is unclear.

Fed officials want to be prepared for any outcome at a time when the economy’s trajectory is marked by grave uncertainty. They are not sure when prices will begin to calm down, to what extent the labor market will recover the millions of jobs still missing after last year’s economic slump, or when they will begin to raise interest rates — which remain at rock-bottom to keep borrowing and spending cheap and easy.

So the central bank’s decision to dial back its other policy tool, large-scale bond purchases that keep money flowing through financial markets, was meant to give the Fed flexibility it might need to react to a shifting situation. Officials on Wednesday laid out a plan to slow their $120 billion in monthly Treasury bond and mortgage-backed security purchases by $15 billion a month starting in November. The purchases can lower long term interest rates and prod investors into investments that would spur growth.

Assuming that pace holds, the bond buying would stop altogether around the time of the central bank’s meeting next June — potentially putting the Fed in a position to lift interest rates by the middle of next year.

The Fed is not yet saying that higher rates, a powerful tool that can swiftly slow demand and work to offset inflation, are imminent. Policymakers would prefer to leave them low for some time to allow the labor market to heal as much as possible.

But the move announced on Wednesday will leave them more nimble to react if inflation remains sharply elevated into 2022 instead of beginning to moderate. Many officials would not want to lift interest rates while they are still buying bonds, because doing so would mean that one tool was stoking the economy while the other was restraining it.

“We think we can be patient,” Jerome H. Powell, the Fed’s chair, said of the path ahead for interest rates. “If a response is called for, we will not hesitate.”

Congress has given the Fed two jobs: achieving and maintaining stable prices and maximum employment.

Those are tricky tasks in 2021. Twenty months into the global coronavirus pandemic, inflation has shot higher, with prices climbing 4.4 percent in the year through September. That is well above the 2 percent price gains the Fed aims for on average over time.

At the same time, far fewer people are working than did before the pandemic. About five million jobs are missing compared to February 2020. But that shortfall is hard to interpret, because businesses across the country are struggling to fill open positions and wages are quickly rising, hallmarks of a strong job market.

For now, the Fed is betting that inflation will fade and the labor market will lure back workers, who might be lingering on the sidelines to avoid catching the coronavirus or because they have child care or other issues that are keeping them at home.

“There’s room for a whole lot of humility here,” Mr. Powell said, explaining that it was hard to assess how quickly the employment rate might recover. “It’s a complicated situation.”

Officials have already been surprised this year by how much inflation has surged and how long that pop has lasted. They had expected some run-up in prices as the cost of dining out and air travel bounced back from pandemic-lockdown lows, but the severity of the supply chain disruptions and the continued strength of consumer demand has caught Fed officials and many economists by surprise.

In their November policy statement, Fed officials predicted that this burst of inflation would fade, but they toned down their confidence on that view. They said previously that factors causing elevated inflation were transitory, but they updated that language on Wednesday to say that the drivers were “expected to be” transitory, acknowledging growing uncertainty.

“Supply and demand imbalances related to the pandemic and the reopening of the economy have contributed to sizable price increases in some sectors,” the statement added.

The Fed is willing to tolerate a temporary bout of quick inflation as the economy reopens from the pandemic, but if consumers and businesses come to expect persistently higher prices, that could spell trouble. High and erratic inflation that persists would make it hard for businesses to plan and might eat away at wage increases for workers who lack bargaining power.

“We have to be aware of the risks — particularly now the risk of significantly higher inflation,” Mr. Powell said. “And we have to be in position to address that risk should it create a threat of more-persistent, longer-term inflation.”

Investors were well prepared for Wednesday’s announcement and took the news that bond buying will slow in stride. The S&P 500 rose 0.7 percent by the end of trading, reaching a new high.

That’s notable because of the market’s tumultuous reaction in 2013, when the Fed hinted that it would soon end a similar program that had been put in place in response to the financial crisis. A repeat of what came to be known as the “taper tantrum” in financial markets appears to have been avoided through the Fed’s ginger communication in recent months.

Mr. Powell said the Fed would be “very transparent” if it should decide to speed or slow the pace of its winding down of the bond purchases, noting that it did not want to surprise markets.

“They’re giving themselves the maximum amount of flexibility,” said Seema Shah, chief strategist at Principal Global Investors, of Wednesday’s statements from the Fed. “In fairness, this is a really uncertain environment, right? And there are things going on which are driving the economy which are really out of the Fed’s control. So they can only try to be responsive.”

Officials have tried to separate their path for slower bond buying from their plans for interest rates. But investors increasingly expect rate increases to start midway through 2022.

The Fed has said that it wants to achieve full employment before raising borrowing costs to cool the economy, and Mr. Powell was clear that the job market has yet to meet that milestone. He said it is possible, but not certain, that it could reach maximum employment next year.

If the Fed has to lift interest rates to contain inflation before the labor market is healed, it could come at a serious cost. While some employees may have retired since the onset of the pandemic, many people who are now sidelined are in their prime working years. They may start searching for jobs again as child-care issues are resolved and health concerns wane.

If the Fed slows the economy before they can, it could be harder for those workers to move into new jobs, leaving the economy with less potential and families with fewer paychecks.

“We’re accountable to Congress and the American people for maximum employment and price stability,” Mr. Powell said, noting that the pace of inflation right now is not consistent with price stability, but that the economy is also not at maximum employment.

He called the Fed’s stance a “risk management” approach.

“He acknowledged that there is a lot of uncertainty around the outlook right now,” said Laura Rosner-Warburton, senior economist at MacroPolicy Perspectives. “Policy needs to have flexibility.”

Matt Phillipscontributed reporting.