Federal Reserve to taper massive US stimulus

Federal Reserve Chairman Ben Bernanke (Reuters)

The Federal Reserve announced Wednesday it would start tapering its massive stimulus program in January, giving a vote of confidence in the recovery of the US economy and job market.

The Fed will buy $75 billion on bonds a month next month, down from the $85 billion monthly asset purchases it has made for a year, the Federal Open Market Committee said after a two-day monetary policy meeting.

Stocks rallied to new record highs after the Fed action, which marked the beginning of the end of five years of its easy-money policy, aimed at helping the world’s largest economy recover from the devastating recession.

“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 FOMC said in a statement.

The Fed said it would pare $5 billion off purchases of Treasury bonds and $5 billion off purchases of mortgage-backed securities each month and likely would take “further measured steps at future meetings” if the economy continues to improve.

On Wall Street, the Dow Jones Industrial Average soared 1.84 percent to finish at 16,167.97, while the broad-based S&P 500 jumped 1.66 percent to 1,810.65.

The Fed, as widely expected, held its key federal funds interest rate at 0-0.25 percent, where it has been for five years to support the recovery.

With its rate tool near zero, the central bank turned to an unprecedented large-scale use of asset purchases, or quantitative easing (QE), in an effort to tamp down longer-term interest rates to stimulate growth and job creation.

Noting the negative impact of the federal government’s tax hikes and spending cuts on growth since the start of the current QE program, the FOMC said it “sees the improvement in economic activity and labor market conditions over that period as consistent with growing underlying strength in the broader economy.”

But the policy panel voiced concern about weak inflation in the tepid economy, saying it was “carefully” monitoring developments showing inflation will move back toward its 2.0 percent objective over the medium term.

Inflation is well below the target. In November, the Fed’s preferred measure, the personal consumption expenditures price index, was up only 0.7 percent at an annual rate.

The lone FOMC dissenter to the change in the asset-purchase program was Boston Fed President Eric Rosengren, who said it was “premature.”

The taper decision took many analysts by surprise. A slight majority had expected the Fed to wait until the January or March meetings to allow time for more data to assess whether the economy would be strong enough to pare back bond purchases.

“The overall impression is one of greater confidence that the economy is gaining momentum, though the Fed is at pains to point out that any rise in rates is still a long way off, even if unemployment dips below the 6.5 percent threshold relatively soon,” said Ian Shepherdson of Pantheon Macroeconomics.

Fed Chairman Ben Bernanke acknowledged in a news conference that the economy had a way to go to get back on track, but insisted the taper did not mean a reduction in the Fed’s support because of the growing size of the bond holdings and the near-zero interest rate.

“We’re not doing less,” Bernanke said. “We have been aggressive to keep the economy growing.”

“I want to emphasize that we are going to be data-dependent. We could stop purchases if the economy disappoints. We could pick them up somewhat if the economy is stronger.”

Bernanke highlighted a change in forward guidance on when the federal funds rate could be increased.

The FOMC said it would likely keep the current near-zero rate “well past the time” that the unemployment rate declines below 6.5 percent, especially if projected inflation continued to run below the Fed’s target.

Bernanke pointed out that most Fed officials saw the first rate hike near the end of 2015 if a broad range of indicators showed the labor market was sufficiently strong.

Asked if Fed Vice Chair Janet Yellen, who is nominated to succeed him when his eight-year tenure ends on January 31, supported the policy decision, Bernanke said: “She fully supports what we did today.”

In updates of September economic forecasts, the Fed projected 2014 gross domestic product growth between 2.8 percent and 3.2 percent, a tenth of a point wider than the prior 2.9-3.1 percent range.

The unemployment rate, which fell to a five-year low of 7.0 percent in November, was expected to fall to a range of 6.3-6.6 percent by the end of 2014, an improvement from the prior estimate of 6.4-6.8 percent.

But the inflation rate still was only seen returning to the Fed’s 2.0 objective in 2015, with a forecast range of 1.5-2.0 percent.