Wednesday, December 18, 2013

Fed Pulls Back on Stimulus


Federal Reserve Chairman Ben Bernanke: "The economy is beginning to make progress"

The US Federal Reserve has announced a slowdown in its effort to boost the US economy. The central bank said it planned to scale back its $85bn a month bond buying program by $10bn a month.
Stimulus of this kind is designed to lower interest rates and boost economic activity. The Fed's governing committee cited stronger job growth as a reason for the decision to begin winding down its program of bond buying. The announcement followed a two-day meeting in Washington DC.

The Fed's decision to begin to ease its extraordinary stimulus efforts also indicates that the central bank believes that the US economy has finally strengthened enough that it no longer needs as much support. The $10bn reduction comes from two areas: the Fed will reduce its US Treasury purchases from $45bn to $40bn per month as well as its buying of mortgage-backed securities (MBS) from $40bn to $35bn per month.

In its forecast for the coming years, the Fed said the employment situation will improve faster than previously expected. It said the unemployment rate will fall to 6.3% in 2014 from its current level of 7%. This could set the pace for further reductions in the Fed's stimulus efforts in the coming year.

In a press conference to discuss the Fed's announcement, Chairman Ben Bernanke said: "If incoming data broadly supports the committee's support for employment we will likely reduce the pace of committee's purchases in further steps at future meetings."
However, he also cautioned: "Continued progress is by no means certain. Adjustments will be deliberate and dependent on incoming information."

  With its decision, the US's central bank is recognizing the improvement in the world's largest economy. US markets cheered the news. But this is by no means a job done. Ben Bernanke spoke about the many Americans who have dropped out of the workforce.  So the Fed is still providing plenty of support to the economy. In exchange for less bond buying, it has made a commitment to keep interest rates near zero for longer.  But given the immediate reaction by financial markets, it appears as if the central bank has successfully managed its shift in policy.  Now, it falls to incoming chairwoman Janet Yellen to continue taking the Fed's foot off the gas.

The Dow Jones surged to close up 292.71 points, or 1.84%. Both the Nasdaq and S&P 500 indexes were up over 1% as well. That is partially because, while significant, the amount of the pullback in bond-buying was slightly less than expected.
"Ultimately this a very small amount - it's symbolic rather than more substantive," Steve Wood, chief market strategist at Russell Investments, commented .
"The takeaway from this is that while the Federal Reserve might be reducing the dosage of the antibiotic, they're not going to be discharging the patient anytime soon."

The Fed also said it remained committed to seeing prices rise before it would completely withdraw its stimulus. The central bank sets a target of a 2% rise in prices annually. Currently, inflation levels are below that threshold, with the most recent consumer price index data showing a 1.2% rise in prices overall and a 1.7% rise in core prices, which exclude volatile food and energy costs.
"Nothing that we did today was intended to reduce accommodation," Mr Bernanke said during the news conference. We are committed to doing what is necessary to getting inflation back to target."

Mr Bernanke insisted that the changing leadership at the Fed had no impact in the committee's decision. Mr Bernanke is scheduled to step down on 31 January 2014 and it is expected that the current vice-chair, Janet Yellen, will be confirmed to take the helm later this week.
"I have always consulted closely with Janet, even well before she was named by the President and I consulted closely with her on these decisions as well. And she fully supports what we did today," said Mr Bernanke.

When asked how he hoped future historians would view his legacy, he remained coy.
"I hope I live long enough to read the textbooks," he said.

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