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US federal reserve cuts bond-buying but stresses easy policy

PUBLISHED : Thursday, 19 December, 2013, 3:10am
UPDATED : Thursday, 19 December, 2013, 4:45pm

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The U.S. Federal Reserve announced plans to trim its aggressive bond-buying program but sought to temper the long-awaited move by suggesting its key interest rate would stay lower for even longer than previously promised.

In what amounts to the beginning of the end of its unprecedented support for the U.S. economy, the central bank said it would reduce its monthly asset purchases by $10 billion to total $75 billion. It trimmed equally from mortgage and Treasury bonds.

"The (policy-setting) committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced," the Fed said after a two-day meeting.

The move, which surprised some investors, was a nod to better prospects for the economy and labor market and marks a historic turning point for the largest monetary policy experiment ever.

U.S. stocks initially dropped, but quickly moved back into positive territory. Similarly, bond prices slid but then bounced back. The dollar rose against the euro and the yen.

"They finally pulled a Band-aid off that they’ve been tugging at for a long time," Rick Meckler, president of hedge fund LibertyView Capital Management in Jersey City, New Jersey.

 

End to an Era?

The Fed’s asset purchase program, a centerpiece of its crisis-era policy, has left it holding roughly $4 trillion of bonds, and the path it must follow in dialing it down is rife with numerous risks, including the possibility of higher-than-targeted interest rates and a loss of investor confidence.

The Fed "modestly" reduced the pace of bond buying in light of better labor market conditions, it said in a statement following a two-day policy meeting.

But in a move likely meant to forestall any sharp market reaction that could undercut the recovery, the central bank also said it "likely will be appropriate" to keep rates near zero "well past the time" that the jobless rate falls below 6.5 per cent.

It was a noteworthy tweak to a previous commitment to keep benchmark credit costs steady at least until the jobless rate hit 6.5 percent. The rate stood at 7.0 per cent in November, a five-year low.

The Fed’s latest so-called quantitative easing program, or QE, was launched 15 months ago to kick-start hiring and growth in an economy that was recovering only slowly from the Great Recession. The Fed’s first QE program was launched in the midst of the 2008 financial crisis.

The Fed widened its growth outlook for 2014 by projecting gross domestic product growth between 2.8 per cent and 3.2  per cent, a tenth point wider than the 2.9-3.1 per cent range it projected in September.

Meanwhile, it lowered expectations for both inflation and unemployment over the next few years, acknowledging the faster-than-expected drop in joblessness to a five-year low of 7 per cent last month.

It expects the unemployment rate to fall to 6.3 per cent to 6.6 per cent by the end of 2014, from a previous prediction of 6.4 per cent to 6.8 per cent, according to the central tendency of policymakers.

Three policymakers now expect the first rate rise to come in 2016, up from only two making that prediction in September, while a strong majority of 12 officials still see the move in 2015.

The Fed has kept interest rates near zero since the depths of the financial crisis in late 2008 and asset purchases have stoked anxiety that they could unleash inflation or fuel hard-to-detect asset price bubbles.

Even some within the Fed have worried the bond purchases could have unintended and economic costly effects.

The unprecedented money-printing has helped drive U.S. stocks to record highs and sparked sharp gyrations in foreign currencies, including a drop in emerging markets this year as investors anticipated an end to the easing.

Earlier on Wednesday, Brazil’s finance minister issued a plea for the Fed to end its buying sooner rather than later to reduce market uncertainty that has kept emerging economies on edge. 

But some have credited the Fed’s asset purchases with stabilizing an economy and banking system that had been crippled by the 2008 financial crisis and with staving off what could have been a damaging cycle of deflation.

One policymaker, Eric Rosengren of the Boston Fed, dissented against the decision, which he felt was premature, according to the statement.

Recent growth in jobs, retail sales and housing, as well as a fresh budget deal in Congress, had convinced a growing number of economists the Fed would trim the bond purchases. The 15-month-old program is meant to put downward pressure on long-term borrowing costs to stimulate investment and hiring.

But many thought the central bank would wait until early in the new year, given persistently low inflation and the fact that the world’s largest economy has stumbled several times in its crawl out of the 2007-2009 recession.

A handful of the Fed’s policymakers had been pushing for the U.S. central bank to better telegraph how it plans to wind down the stimulus program, or to clarify its longer-term intentions to keep policy loose.

The Fed policy meeting was the penultimate one of Chairman Ben Bernanke’s tenure. His second four-year term as chairman of the central bank expires on Jan. 31, just two days after the close of the Fed’s first policy meeting of 2014.

Janet Yellen, the Fed’s vice chair and a strong proponent of the Fed’s aggressive response to the recession, is positioned to succeed Bernanke.

Bernanke said in a press conference following Fed's announcement that Yellen was closely consulted before the Fed decided to slow its bond purchases.

The U.S. Senate is expected to vote to confirm Yellen for the post by the end of this week.

Reuters, AFP

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