I just read the speech of Charles Plosser, President of the Federal Reserve Bank of Philadelphia, that he gave last Friday. It was widely reported as the Fed's "Exit Strategy" from its very successful effort to save the economy. Mostly, I agree with him, especially his belief that the Fed's action be made clear long before they actually do something. The markets do over-react and go crazy whenever anything unexpected happens.
My problem is that he wants a formula to sell a pre-determined amount of the bonds they own each time the Fed raises interest rates, as they surely will. They will only raise rates as the economy grows and needs less support. Therefore, the market should be in a better position to buy those bonds that the Fed owns, right?
You'll recall that the Fed has been buying mortgage-backed-securities or bonds collateralized with home mortgages. In effect, the Fed has made almost every mortgage loan to buy homes since the recession started, and they don't like owning those "mortgages." They want to sell them. Here's my fear: what happens if the economy is growing and the Fed raises interest rates but sells too many bonds for the market to easily absorb?
To sell those mortgages into a soft market, they will have to sell them at a loss and at higher interest rates.
It is no secret that higher interest rates will reduce home sales, and that, ladies and gentlemen, is not something this country needs!
