Fed decides to scale back stimulus

The Federal Reserve Board announced Wednesday its long-awaited decision to begin the pull back from its bond-buying program.

While the speculation about when this would happen and how much they’d pull back has been written about much of the second half of the year, the move is still significant for the markets since it means the Fed believes the economy is finally on the right track.

MJ Lee covered the story for Politico with a straightforward lead:

The Federal Reserve announced on Wednesday that it will begin pulling back on its efforts to boost economic growth through monthly bond purchases, arguing the economy is gaining enough strength for the central bank to begin its retreat.

Financial markets have closely watched and speculated on when the Fed would begin scaling back its monthly bond buys, the central bank’s signature response to the recession brought on by the financial crisis, and the issue has also stirred political debate with Republicans charging the Fed is intervening too much in financial markets and the economy.

On Wednesday, the Fed said its policy setting committee has decided to “modestly” scale back the pace of its monthly asset purchases by $10 billion and will now buy $75 billion worth of Treasury and mortgage-backed bonds each month starting in January.

The Los Angeles Times story by Andrew Tangel started out with the end-of-day rally in the stock markets set off by the news:

Stocks rallied nearly 2% after the Federal Reserve announced it would begin scaling back its stimulus program early next year.

The Dow Jones industrial average added 292.71, gaining 1.8% to 16,167.97 at the closing bell Wednesday. The broader Standard & Poor’s 500 index rose 29.65 points, or 1.7%, to 1,810.65.

The late-day rally pushed the Dow and S&P 500 to new all-time closing highs, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

The technology-focused Nasdaq composite rose 46.38 points, or 1.2%, to 4,070.06.

Wall Street has been obsessed over how long the Fed would continue its easy-money policies that have helped boost this year’s stock rally.

“The market sees it as the right thing to do,” said J.J. Kinahan, chief strategist at TD Ameritrade. “It views it as a vote of confidence that the [economy] is as healthy as the numbers have been portraying it.”

While it might be a vote of confidence, the Wall Street Journal’s story by Victoria McGrath and Jon Hilsenrath pointed out at the top that the Fed will likely continue its policy changes gradually:

The Fed also sought to enhance its commitment to keep short-term interest rates low for a long time after the bond-buying program ends. Fed officials repeated that they won’t raise their benchmark federal funds rate from near zero until unemployment drops at least to 6.5%, as long as inflation remains in check. They also added language to the statement saying, “it likely will be appropriate to maintain the current target range for the federal funds rate well past the time” that the jobless rate dips below the 6.5% threshold.

U.S. stock prices fell as the news emerged, but rebounded almost immediately. The Dow Jones Industrial Average and the S&P 500 index both ended the day at record closing levels. Prices on Treasurys slipped, pushing the yield on the 10-year note up to 2.885%

Fed Chairman Ben Bernanke said in his press conference after the central bank’s two-day meeting that future steps on the bond-buying program will depend on the economic data. He said if the economy continues to improve as expected, the Fed could make “a measured reduction” at each of its eight meetings next year. But if the economy disappoints, the Fed could “skip a meeting or two,” and if it picks up more than expected it could scale back the bond buys “a bit faster,” he said.

The New York Times story by Binyamin Appelbaum added the context that by many measures the economy isn’t that robust and could be a while before the labor market returns to pre-crisis levels:

The Fed is struggling to calibrate its stimulus campaign in an environment of steady but mediocre growth. The unemployment rate has declined over the last year, reaching 7 percent in November. That is still a high rate by historical standards, and other measures of the labor market look even worse. Wages are barely rising, and the share of adults with jobs has not climbed since the recession.

A variety of indicators suggest that the American economy may be growing more quickly than analysts had predicted during the final quarter of the year, and Fed officials expect somewhat faster growth in the coming year. But the persistence of low inflation indicates that the economy still is operating well below its capacity.

By one measure, prices increased by only 0.7 percent during the 12 months that ended in October. “We don’t have a good story about why this is,” James B. Bullard, president of the Federal Reserve Bank of St. Louis, said in November. “You would have expected to see more inflation pressure by this point. We haven’t seen it.”

The Fed over the last year has purchased more than $1 trillion in Treasury and mortgage-backed securities in an effort to encourage job creation.

That’s a huge amount of stimulus by any measure. And the Fed has a hard line to walk given that any announcement seems to cause volatility in the markets. Now that investors know the plan, it’s likely to cause fewer issues moving forward. But only time will tell if the economic recovery will continue, giving the Fed some room to pull back further.