The Federal Reserve will probably wait a full year after it begins raising interest rates before it stops buying bonds, according to a Goldman Sachs & Co. report.
An analysis of data showing how the U.S. central bank’s bond purchases since the global financial crisis have reshaped portfolios across the financial industry, suggests ending the buying could have a significant impact on the economy.
Uncertainty surrounding the magnitude of that impact will cause the Fed to take its time before ending reinvestments of the maturing securities it holds, Zach Pandl, a New York-based senior economist at Goldman, said in a June 26 report.
The Fed must decide whether to reinvest $216 billion of proceeds from maturing Treasury securities in 2016, or shrink its balance sheet by allowing the debt to expire.
By not reinvesting, the Fed would increase the supply of securities available to investors and put upward pressure on yields, adding another dimension of monetary tightening to the central bank’s interest rate increases.
Policy makers’ quarterly projections released on June 17 show that most of them continue to expect to begin raising rates later this year for the first time since 2006.
U.S. private-sector holders of debt like investment funds, banks and insurance companies reduced their holdings of Treasuries the most when the Fed was purchasing them, said Pandl. This group of investors would be holding $300 billion more long-term Treasuries than they do now if their share of the debt were the same as it was before the central bank’s purchase programs began, he said.
The Fed started its unprecedented bond purchases to reduce longer-term borrowing costs in 2008 as it cut the fed funds rate almost to zero. It bought Treasuries and mortgage debt in three waves of so-called quantitative easing that ended in October 2014, amassing a $4.2 trillion portfolio in the process.
Fed Chair Janet Yellen said during a press conference following the policy-setting Federal Open Market Committee’s June 16-17 meeting that officials had not yet decided when they would stop reinvesting. New York Fed President William C. Dudley told reporters after a June 5 speech in Minneapolis he would like to have raised rates to a “reasonable level” -- perhaps 1 percent or 1.5 percent -- before doing so.
The fact that the U.S. private sector’s share of holdings of Treasuries maturing in 10 to 30 years’ time fell as the Fed bought them constitutes “some evidence” that the purchases eased financial conditions by removing interest-rate risk from the market, Pandl said. That makes the consequences of a decision to put the bonds back into private hands by ending purchases more unpredictable, he said.
“Our previous view had been that full reinvestment would end six months after the start of rate hikes, implying mid-2016 on our current forecast for liftoff in December,” Pandl wrote in the report. “We now think twelve months after liftoff looks more likely, implying late-2016 or early-2017.”