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The market’s next Fed fear: The exit strategy

CNBC, Sep 22, 2014

In another month, investors won’t have Federal Reserve money stimulus to juice up the market. In return, they do have one thing they might rather not see: An exit door.

Even if the U.S. central bank didn’t exactly start flashing the lights to indicate that the easy-money party is over, it at the very least indicated that it won’t go on forever. The monthly bond-buying program—quantitative easing—almost certainly will end in October, and the Fed last week gave a rough outline for how its zero interest rate policy will unwind in the years ahead.

Prior to the Fed Open Market Committee meeting, market participants had trained their gazes at two phrases within the statement: “Considerable time,” in reference to how long it would take from the end of QE to the first rate increases, and “significant underutilization of labor resources” regarding the job situation.

Both phrases stayed in the statement, easing consternation on Wall Street, which worried that the removal of either would be a hawkish policy stance.

What the FOMC also provided was a separate statement called “Policy Normalization Principles and Plans.” The document is a blueprint toward what factors will be taken into consideration as the Fed moves away from zero interest rates and back toward a normal regime. 

The critical section detailing how it will determine the rate structure:

When economic conditions and the economic outlook warrant a less accommodative monetary policy, the Committee will raise its target range for the federal funds rate.

During normalization, the Federal Reserve intends to move the federal funds rate into the target range set by the FOMC primarily by adjusting the interest rate it pays on excess reserve balances.

During normalization, the Federal Reserve intends to use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate. The Committee will use an overnight reverse repurchase agreement facility only to the extent necessary and will phase it out when it is no longer needed to help control the federal funds rate.

Fed watchers undoubtedly will spend many hours parsing their way through the language and exactly how it will accomplish policy normalization.

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