Fed to begin easing bond policy
WASHINGTON — The Federal Reserve took its first step toward curtailing its unprecedented efforts to boost the economic recovery — a sea change in policy that over time will result in interest rates drifting higher for businesses and consumers alike.
After months of skittishness among policymakers and intense anticipation across the globe, the central bank said Wednesday that it would pare its large bond-buying stimulus program by $10 billion a month, beginning next month.
The decision marks what is expected to be the start of a gradual unwinding of the Fed’s historic efforts to revive an economy debilitated by the financial crisis six years ago.
The announcement was greeted with cheers on Wall Street and by many others in the financial industry. Stocks soared, in part, because the scale-back of bond purchases amounted to a validation that the economy and job market were finally on a more solid footing.
“We’re hopeful that the economy will continue to make progress and that we’ll begin to see the whites of the eyes of the end of the recovery and the beginning of the more normal period of economic growth,” said Fed Chairman Ben S. Bernanke in a news conference following the two-day meeting and policy announcement.
Investors also took heart in the Fed’s decision to make a relatively small reduction in its program of buying
$85 billion of Treasury and mortgage-back bonds every month, a program aimed at holding down long-term interest rates to boost growth and lower the unemployment rate.
The central bank shaved the purchases by $5 billion a month in each of the two bond categories and noted that it would scale back the pace of buying “in further measured steps at future meetings” as long as the labor market continues to improve and inflation stays in check.
If economic growth slows, Bernanke said, the Fed could skip additional reductions for “a meeting or two” and could go faster if growth picks up.
“My expectation is for similar moderate steps going forward through most of 2014,” when the program would end, he said.
To allay any concerns about the central bank’s commitment to support economic growth, the Fed strengthened its statement on its other, main stimulus tool — short-term interest rates.
The Fed said it would keep those rates at or near zero until “well past the time” that the unemployment rate drops below 6.5%, expected late next year. In the past, the Fed has said it would hold rates low as long as joblessness was above 6.5%. November’s unemployment rate was 7%.
“We’re still going to buy assets at a high rate,” Bernanke said of the bond purchases. “We’re providing a great deal of accommodation to the economy.”
With inflation very subdued and economic growth still considered moderate, mortgage rates “in all likelihood, will rise a little bit,” but nothing like “the kind of spike we saw in the summer,” said Gary Schlossberg, senior economist at Wells Capital Management.
Shortly after Bernanke hinted of a possible pullback in bond purchases last May, the 10-year bond yields, which track home loans, shot up. They since have come back down a little.
Russell Goldsmith, chief executive of City National Bank in Los Angeles, agreed: There will be “a certain amount of psychological shock” for home buyers and those looking to refinance, he said, but mortgage rates still will be historically low.
With the economy showing “solid job creation,” the time was right to start reducing the bond purchases, Goldsmith said.
“I’m absolutely convinced it was the right move,” he said. “It’s like a patient who’s been very sick and been on intensive antibiotics, and the doctor comes in and says, ‘You know what, pal? You’re looking better. We can throttle back on the antibiotics.’”
Fed officials were swayed to begin a reduction in their purchases after a string of positive economic data. Job growth has picked up recently, exceeding 200,000 on average over the last four months. Auto and retail sales have made strong gains, as have exports and home-building.
What’s more, the two-year budget deal in Congress has eased worries and uncertainties over more political gridlock on the budget and possibly another government shutdown. Alluding to that, the Fed statement said that even though fiscal policy was still hampering growth, “the extent of restraint may be diminishing.”
In a new forecast, the Fed slightly upgraded its growth outlook, projecting that the economy would expand at a solid pace of 2.8% to 3.2% next year, up from 2.2 to 2.3% this year.
Fed officials now see the nation’s unemployment rate dropping to as low as 6.3% by the end of next year and returning to a normal rate in the mid-5% range by 2016.
Fed policymakers, however, continue to be concerned about inflation, not that it would rise but that it might actually drift lower.
Price growth is running well below the Fed’s annual target of 2%, raising the risk of deflation, a condition of falling prices that depresses investments and hiring and is very difficult to cure.
Fed officials project inflation will start moving back toward its long-term target as economic growth picks up in the U.S. and globally. But Bernanke warned: “If inflation does not show signs of returning to target, we will take appropriate action.”
On the whole, Bernanke stressed that the economy “has much farther to travel.”
“The recovery clearly remains far from complete,” he said in his final scheduled news conference, part of an effort he began in 2011 to improve communications with the public.
Fed Vice Chair Janet L. Yellen, who is expected to be confirmed as his replacement by the Senate this week, will take over after Bernanke’s term ends Jan. 31.
Bernanke said he did not rush a decision to taper before he left office and that he consulted with Yellen on Wednesday’s move, as he has with her on previous actions. “She fully supports what we did today,” Bernanke said.
Analysts had said it was a toss-up whether the Fed would vote to taper at the meeting, with many betting that policymakers would wait until the first three months next year. Either way, economists predicted the reductions would be small.
The Fed said it would reduce its purchases of mortgage-backed securities to $35 billion a month, from $40 billion, and reduce its purchases of Treasury securities to $40 billion, from $45 billion.
The stimulus program, which began in September 2012, has helped swell the Fed’s asset holdings, or balance sheet, to about $4 trillion. Five years ago, it was well below the $1-trillion mark. The Fed had launched a similar bond-buying program in March 2009 as the Great Recession was coming to an end, officially. It lasted a year and added $1.75 trillion to the Fed’s holdings. A second program, lasting seven months to June 2011, added $600 billion.
Analysts worry that the Fed’s expanding balance sheet could cause instability in financial markets and that miscalculations in selling bonds could trigger sharp reactions in financial markets.
Wednesday’s vote to start reducing bond purchases was 9 to 1. Eric Rosengren, president of the Federal Reserve Bank of Boston, dissented, saying he believed the reduction was premature, given the “still elevated” unemployment rate.
