It will come as no surprise if the Federal Reserve has an announcement to make when its latest policy meeting ends Wednesday: That it’s ready to begin paring its enormous $4.5 trillion portfolio containing Treasurys and mortgage bonds.
The Fed expanded its bond holdings — the major assets on its balance sheet — in the years after the financial crisis erupted in 2008. It bought the bonds to try to hold down mortgage and other loan rates and support a fragile economy. The Fed stopped buying new bonds in 2014 but kept its balance sheet high by reinvesting the proceeds of maturing bonds.
Now, with a much stronger economy, Fed officials are expected to announce a starting date to begin allowing the bond holdings to shrink gradually. No one is quite sure how the financial markets will respond over time.
One thing not expected Wednesday is any change in the Fed’s key policy rate, which remains in a low range of 1 percent to 1.25 percent. The central bank may signal how likely a rate hike is by December, when some analysts foresee the next increase.
Here are three things to watch for after the Fed’s meeting ends:
REDUCING THE BALANCE SHEET
Just as the Fed had never before engaged in a bond-buying spree of such magnitude, it has never attempted to shrink a portfolio that is now roughly five times its size before the financial crisis.
Under the plan the Fed announced in June, it will start to allow a slight $10 billion in holdings to roll off the balance sheet each month — $6 billion in Treasurys and $4 billion in mortgage bonds. That figure would inch up by $10 billion each quarter until it reaches $50 billion in monthly reductions a year from now. At this rate, the Fed’s balance sheet would still be above $3 trillion by late 2019.
Those sales are expected to exert modest upward pressure on long-term rates, like mortgages. The Fed has given investors months to digest its forthcoming move and has stressed that the paring of its balance sheet will proceed extremely gradually. Still, the risk exists that investors could become spooked by the rising number of bonds being transferred back into private hands. If that were to happen, long-term rates might surge undesirably high, which could weigh on the economy.
Any damage in the markets could also extend to assets such as stocks, which have set record highs as investors have shifted money into stocks and away from low-interest bonds. There is also concern that rates could climb faster if…