Still, the tools the U.S. central bank plans to employ, such as paying interest on reserves, “have been used quite frequently by central banks and they seem to work,” Bernanke told the House committee. The Fed finances the expansion of its portfolio by creating bank reserves. While policy makers gained the ability to pay interest on this cash in 2008, they’ve never used it to tighten policy.
Under the current exit strategy, the Fed would cease reinvesting some or all principal payments from its securities, revise its interest-rate outlook, raise the federal funds rate and then start selling housing debt to eliminate it from its holdings in three to five years.
Central bankers have kept the target on overnight loans between banks at zero to 0.25% since December 2008. They plan to help move the effective rate by changing the interest on excess reserves, at 0.25% since 2008, and using so-called reserve-draining tools, according to the minutes from the Federal Open Market Committee’s June 2011 meeting.
“The one thing we could do differently” is “hold some of the securities a little longer,” Bernanke said Feb. 27. “We could even let them just run off.”
Policy makers are reconsidering bond sales in response to criticism that their third round of purchases is exacerbating the potential for the central bank to, “in a robotic fashion, dump assets” on the market, causing interest rates to climb rapidly, said Ethan Harris, co-head of global economics research at Bank of America Corp. in New York.
The Fed could refrain from selling bonds for this reason and to avoid taking losses on its securities holdings, Governor Jerome Powell said in a Feb. 22 speech in New York. Given the increase in the Fed’s balance sheet, the period of time during which it’s appropriate to unload assets “probably has lengthened,” San Francisco Fed President John Williams also told reporters after a Feb. 21 New York speech.
“They’re trying to address the new favorite concern, which is: ‘The exit will be disruptive to markets, so stop buying those assets because you’re making the exit even harder,’” said Harris, a former New York Fed researcher and author of “Ben Bernanke’s Fed: The Federal Reserve After Greenspan.”
With the chance of large asset sales receding, the yield on 10-year Treasuries probably will remain between 1.8% and 2.25% this year, said Krishna Memani, the New York-based chief investment officer of OppenheimerFunds Inc.’s $79.1 billion fixed-income portfolio.
Benchmark 10-year Treasury yields climbed one basis point, or 0.01 percentage point, to 2.05% at 1:05 p.m. in New York, according to Bloomberg Bond Trader data.
“The Fed is saying that if the economy stabilizes, yes, rates will rise, but it’s not imminent and don’t panic about the fact we’re going to sell trillions of securities,” Memani said. “The last thing the Fed wants to do is snuff out the recovery in the housing market” by putting pressure on mortgage bonds.
Bernanke said Feb. 27 it’s “worth discussing” whether the Fed should use guidance on how long it plans to hold its securities as a “substitute” for asset-purchase stimulus.