During his final Federal Open Market Committee meeting as chairman of the Federal Reserve, Ben Bernanke and co continued on the path set in December, again cutting back asset purchases.
On Wednesday, the FOMC announced a $10 billion reduction in its
bond-buying program to $65 billion a month. The Fed will cut monthly
mortgage bond purchases to $30 billion from $35 billion. Treasury
purchases will go from $40 billion to $35 billion.
The stock market initially ticked lower on the news, furthering a
downward trend leading up to the 2 p.m. release. Following the release
The Dow Jones Industrial Average was down 1.3% and the S&P was down
about 1.1%. The 10-year treasury note yield held fast, down to 2.71.
In a press release announcing the reduction, the FOMC
wrote, “Information received since the Federal Open Market Committee met
in December indicates that growth in economic activity picked up in
recent quarters. Labor market indicators were mixed but on balance
showed further improvement.”
In wording nearly identical to last month’s taper announcement, the
release noted that the decline unemployment rate remains higher than the
committee would like, but household spending and businesses investment
are accelerating, even as home buying slows. Again the committee wrote,
“Fiscal policy is restraining economic growth, although the extent of
restraint is diminishing. Inflation has been running below the
Committee’s longer-run objective, but longer-term inflation expectations
have remained stable.”
Looking ahead, the FOMC once again noted that, “the Committee will
likely reduce the pace of asset purchases in further measured steps at
future meetings. However, asset purchases are not on a preset course,
and the Committee’s decisions about their pace will remain contingent on
the Committee’s outlook for the labor market and inflation as well as
its assessment of the likely efficacy and costs of such purchases.”
The Fed maintained expectations that the federal funds target rate of
0% to .25% will remain low as long as unemployment remains above 6.5%.
They expect inflation to be at most a half percentage point above its 2%
long term target for one to two years. The statement reiterated
anticipation that targets will hold “well past”when the unemployment
rate declines below 6.5%.
The Fed purchased $85 billion worth of bonds each month for most of
2013 in an effort to stimulate the laggard economy. Last month, citing
moderate economic expansion, the FOMC cut monthly asset purchases by $10
billion, while maintaining tight control on interest rates. Discussing
the Fed’s December decision in a press conference Bernanke noted that
“even after this reduction we will be continuing to add to our
securities holdings at a rapid pace.”
While global markets initially responded favorable to the announcement,
stocks have trended down since the turn of the year. In the last two
weeks investors around the world have been sharply selling off equities
as emerging markets falter. Experts say that the Fed’s December taper
was a catalyst for recent moves, even if it took a few weeks to trickle through.
“If you think back to last April, May, June when the fed was really
hinting at tapering,” notes Kathy Jones, a fixed income strategist at
Schwab, “we started to see some of riskier markets globally start to
decline, not hugely but there was a decline in emerging market
currencies, and commodity prices had already been falling for quite some
time. I think that was an indication that the proverbial punch bowl was
being pulled away.”
Following the FOMC June meeting, Bernanke unveiled plans to begin
cutting back asset purchases within six to 12 months. At that point
investors began to realize that liquidity would be leaving the global
economies that had benefited from the Fed’s open pocketbook. The Dow
lost more than 200 points that day and the 10-year treasury note yield
jumped to 2.34%.
Markets rallied when the Fed ultimately declined to taper in
September and again in October. But once tapering finally began, and
markets came to anticipate more, investors began fleeing risky assets in
favor of safer havens.
“My interpretation is the first phase was a recognition that there
was a frothiness to certain markets,” says Jones. “In the second phase
we are uncovering the unwinding of positions people have probably had
for a number of years. One that we talk about is the carry trade, which
is where you borrow in, say, U.S. dollars because rates are so low and
you invest in higher yielding currencies and earn the spread. When you
start to unwind those trades after people have had them on for a couple
of years, that can go very very fast.” She calls disappointing data from
China’s Purchasing Manager Index the “final straw” that sent markets
into their current decline.
Jones, like most Fed watchers, expected a $10 billion reduction to
bond purchases, evenly split between mortgage backed securities and
treasuries. While she believe “everything” factors into such decisions
she notes that the Fed tends not to set policy based on global
conditions, instead focusing on what is happening at home. While the Fed
still hasn’t hit it’s targets on inflation and employment things seem
to be improving.
After the economy added 200,000 or more jobs in both October and
November, the light 74,000 jobs added in December caught many by
surprise. But with many saying that the December slow down was due to bad weather, most didn’t expect one number to convince the Fed to change course.
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