Fed cuts QE pace to $75B on labor market outlook

Long-awaited first step in program to cut back monthly purchases to support recovery

Dec 18, 2013 @ 2:20 pm

interest rates, economy, bonds, fixed income, ben s. bernanke, federal reserve
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It starts: Fed chairman Ben S. Bernanke has started the taper. (Bloomberg News)

The Federal Reserve is cutting its monthly bond purchases to $75 billion, from $85 billion, taking the first step toward unwinding the unprecedented stimulus that Chairman Ben S. Bernanke put in place to help the economy recover from the worst recession since the 1930s.

“In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the committee decided to modestly reduce the pace of its asset purchases,” the Federal Open Market Committee said Wednesday at the conclusion of a two-day meeting in Washington. The Fed's purchases will be divided between $40 billion in Treasuries and $35 billion in mortgage bonds starting in January.

Mr. Bernanke, in the final weeks of his eight-year tenure, is curtailing the purchases that swelled the Fed's balance sheet almost to $4 trillion as he sought to put millions of jobless Americans back to work. The policy, supported by his designated successor, Vice Chairman Janet Yellen, stirred concern it risks inflating asset-price bubbles even as its economic benefits ebbed.

“If incoming information broadly supports the committee's expectation of ongoing improvement in labor-market conditions and inflation moving back toward its longer-run objective, the committee will likely reduce the pace of asset purchases in further measured steps.” The committee repeated that purchases are “not on a preset course.”

Treasuries fell after the decision, pushing the yield on the 10-year note to 2.9% from 2.84% late Tuesday. Stocks extended gains.


The central bank left unchanged its statement that it will probably hold its target interest rate near zero “at least as long as” unemployment exceeds 6.5%, so long as the outlook for inflation is no higher than 2.5%.

The panel added that it “likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below” the Fed's 2% goal.

Price gains have lagged below the committee's long-run target. The central bank's preferred gauge of inflation, excluding food and energy, climbed 1.1% in the year through October. It has not breached 2% since March 2012.

Boston Fed President Eric Rosengren dissented, saying that changes on the bond-purchase program were “premature until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate.”

Policymakers met amid signs the economy and labor market were gaining strength, even as inflation remained subdued.


The jobless rate fell to 7% in November, a five-year low, as employers added a greater-than-forecast 203,000 workers to payrolls. Unemployment was down from 10% in October 2009, during the recession, and up from 4.4% in May 2007.

Retail sales climbed by the most in five months in November, a sign that consumer spending was strengthening as the holiday season began. Industrial production last month increased by the most in a year, a Fed report showed this week.

Companies including Ford Motor Co. are benefiting from rising demand for new cars. Ford said this month it plans to add 5,000 jobs in the U.S. and will introduce 16 new vehicles in North America next year. The payroll expansion will continue following the hiring of almost 6,500 people in 2013.

Stocks have surged on stronger corporate earnings and continued Fed stimulus. The S&P 500 closed at a record 1,808.37 on Dec. 9 and was up 25% for the year as of Tuesday.

The Fed's low interest rates have prompted consumers to buy homes or refinance existing mortgages, sparking a recovery in the housing market that was at the center of the financial crisis.

Housing prices climbed 13.3% in the 12 months through September, according to an S&P/Case-Shiller index of prices in 20 cities. The pace of home construction reached a more than five-year high in November as builders added to inventory to keep pace with demand, a report Wednesday from the Commerce Department showed.

Rising stocks and home values are boosting household wealth, giving consumers the wherewithal to keep spending. Many have invested in improvements to their homes, lifting profits at companies such as Home Depot Inc., the largest U.S. home-improvement retailer.


“This is one of the stronger-looking points of the recovery,” said Alan MacEachin, a corporate economist at Navy Federal Credit Union. “We've had a couple of false starts, but now you've got the cumulative effects of an improving job market, coupled with the wealth effect from record stock levels.”

Yet with inflation so low, the economy could be at risk of deflation, were growth to slip, he said. “One of the Fed's biggest fears right now is if the economy were to slow significantly, that's going to put more downward pressure on inflation.”

Growth so far has lagged behind previous recoveries. In the 17 quarters since the recession ended, the economy has expanded at an average annualized rate of 2.3% each quarter. That compares with an average of 3.2% over the same period following the 2001 and 1991 recessions, and 5% following the 1982 recession.

Gross domestic product will expand 2.6% next year after gaining 1.7% in 2013, according to the median forecast of economists surveyed by Bloomberg from Dec. 6 to Dec. 11.

Economists were divided on whether the FOMC would begin tapering bond purchases Wednesday. Thirty-four percent of economists in a Dec. 6 Bloomberg survey said the Fed would act at today's meeting. Twenty-six percent predicted a January taper and 40% said March.

The Fed's debate over when to taper purchases has dominated central banking discussions for much of the year, setting off waves of volatility in financial markets. In May, Mr. Bernanke told Congress that the Fed may slow its purchases during the “next few meetings.”

The yield on the 10-year Treasury climbed to as high as 3% in September from as low as 1.61% in May, as investors anticipated a reduction in Fed stimulus. The national average 30-year fixed-rate mortgage climbed to 4.58% in late August from 3.35% in May, according to Freddie Mac.

“As soon as they started talking about tapering, they raised interest rates,” said Julia Coronado, chief economist for North America at BNP Paribas and a former Fed economist.


Before the September FOMC meeting, the majority of economists in a Bloomberg survey expected the Fed to begin reducing purchases. The committee surprised markets by refraining from tapering, citing tighter financial conditions and saying it needed to see more evidence of lasting improvement in the economy.

Mr. Bernanke, whose term ends Jan. 31, orchestrated the most aggressive easing in the Fed's 100-year history and expanded its powers as he battled the financial crisis and then sought to keep the economy growing.

He pumped up the central bank's balance sheet to $3.99 trillion from $869 billion in August 2007 and has held the main interest rate close to zero since December 2008.

As the crisis spread, Mr. Bernanke created mechanisms to lend to U.S. government bond brokers, buy the commercial paper of banks and corporations, and to finance securitized loans to students, car buyers, small businesses and credit-card borrowers.

Mr. Bernanke's actions provoked the strongest political backlash in three decades. In January 2010, he was confirmed to a second term with a vote of 70-30, the narrowest confirmation for any Fed chief in history. After the Fed said in November 2010 that it would buy $600 billion of bonds, House Speaker John Boehner of Ohio and three other Republicans sent Mr. Bernanke a letter expressing “deep concerns.”

Ms. Yellen, who is awaiting a Senate vote on her nomination as chairman, has supported Mr. Bernanke's policies. During her confirmation hearing last month, she said unemployment is “still too high, reflecting a labor market and economy performing far short of their potential.”

Ms. Yellen and Mr. Bernanke are “both driven by the same framework and same vision of the world,” Ms. Coronado said.

(Bloomberg News)


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