Fed to Taper Bond Buying Program in January

Will keep short-term interest rates near zero

Fed to Taper Bond Buying Program in January
December 20, 2024

The Federal Reserve said on Wednesday it would bring its monthly bond-buying campaign down to $75 billion —a $10 billion monthly reduction — beginning in January 2014. Wishing to pacify concerns that it was cutting back on the stimulus program too quickly, the Fed reiterated that short-term interest rates would remain unchanged for the foreseeable future.

"The committee sees the [recent] improvement in economic activity and labor market conditions … as consistent with growing underlying strength in the broader economy," the committee said in a statement released on Wednesday.

The highly anticipated announcement came after a two-day meeting of the Fed’s policy-making committee in Washington. The Fed Governors were clearly influenced by several recent, positive economic items:

  1. Solid Domestic Job Growth – The US economy added 203,000 jobs last month, cutting the unemployment rate to 7%, its lowest rate in five years. This brought the four-month job growth average to 204,000, up sharply from the prior four-month average of 159,000 per month. Moreover, job quality is also rising, as manufacturing and construction job growth reached their highest levels in 18 months.

  2. Robust Economic Growth – The Commerce department reported earlier this month that the US economy expanded at a 3.6% rate in Q3, its strongest performance in 18 months.

  3. Improving Trade Outlook – The Commerce Department also reported a record high in total exports of $192.7 billion, up 18% from September. At the same time, US imports rose just 4.5%, resulting in a narrowing of our monthly trade deficit to $40.6 billion.

  4. Improving Housing Outlook – New home sales surged 25.4% in October versus the previous month’s rate, the highest increase in six months. This lifted the year-over-year increase to 22%.

Reaction to the news is positive

Speaking to the Wall Street Journal, Neil Williams, chief economist at Hermes Fund Managers, which oversees $40 billion in assets, said, “The important thing is that the Fed is still throwing liquidity at the market, just with a slightly smaller bucket.”

"The taper is not a surprise," Michael Feroli, chief U.S. economist at JPMorgan Chase in New York, wrote in a note reported by Bloomberg. He said that the committee "seems pretty eager to get out of the business of asset purchases, and they are now on a path to do that within a year."

Nick Verdi, an analyst with Barclays Capital, said that the Fed tapering made the dollar a more attractive investment to overseas investors. As reported by BBC News, Verdi said "Even though the Fed has committed to keeping interest rates low for now, at some point they will have to start to rise, and investors are betting on that."

Stocks jump at home and abroad

The stock market greeted the news with enthusiasm, as the Standard & Poor’s 500 index jumped more than 1.5 percent after the announcement in late-day trading on Wednesday. The Dow Jones Industrial Average shot up nearly 300 points, and shares in major banks, such as JPMorgan Chase, Citigroup and Bank of America, also climbed. Across the board, investors treated the news as a vote of confidence for the economy’s slow-but-steady rebound.

Overseas, the same sense of confidence was being felt Thursday morning, as global stock markets surged and the dollar hit a five-year high against the Yen. This was good news for Japanese stocks; a weaker Yen makes Japanese products more affordable to overseas buyers.

Bernanke holds press conference

At a news conference held after Wednesday’s announcement, Federal Reserve Chairman Ben Bernanke said that the Fed’s decision is a reflection of the economy’s continued growth, and that he expects the Fed to make further cuts to bond buying through 2015.

“We have been aggressive to try to keep the economy growing, and we are seeing progress in the labor market,” said Bernanke.

Although falling to 7 percent in November, unemployment remains a vexing problem for the economic recovery. The job market has been slow to rebound as rapidly as analysts had predicted; wages are rising slowly, and the percentage of adults with jobs remains at recession levels. Still, many Fed officials believe unemployment will drop to 6.5 percent by the end of 2014.

Addressing the Fed commitment to hold interest rates low throughout much of 2014, Bernanke said "I expect there will be some time past the 6.5 percent [unemployment threshold] before all of the other variables we'll be looking at will line up in a way that will give us confidence that the labor market is strong enough to withstand the beginning of increases in rates."

From late 2012 until the end of this year, the Federal Reserve has bought up more than $1 trillion in bonds — mostly Treasury bills and mortgage-backed securities — in a continued effort to spur economic expansion by keeping interest rates low.

What Does All This Mean to MoneyTips Readers?

Our key takeaway from the Fed announcement that it is tapering (but not eliminating) bond buying — while simultaneously holding down interest rates — is that the economy is clearly improving, but still needs stimulus; albeit at a gentler pace. This clear but measured action suggests our economy is moving in the right direction, but that the Federal Reserve is maintaining its vigilance for now.

Let the free Retirement Planner by MoneyTips help you calculate when you can retire without jeopardizing your lifestyle.

Photo ©iStockphoto.com/Camrocker

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