Dollars & Sense

Federal Reserve shows confidence in the recovery by scaling back stimulus

Updated: 2013-12-19T07:23:30Z

By MARK DAVIS

The Kansas City Star

A stronger outlook for jobs and the economy gave the Federal Reserve enough confidence Wednesday to scale back its all-out effort to fuel the nation’s recovery from the Great Recession.

Stocks soared to record highs on the news, which many had not expected to hear until January or even March.

“We’re really at a point where we’re getting to the self-sustaining recovery the Fed has been talking about,” said Scott Anderson, chief economist at Bank of the West. “It really seems like that’s going to come together in 2014.”

The Fed said it would reduce the massive bond buying it began in September 2012 as the off-and-on recovery sputtered. Its bond purchases have held down long-term interest rates, particularly mortgage rates, helping to stir economic activity.

Its cutback starting next month will be slight, buying $75 billion in bonds a month instead of $85 billion.

And the Fed reinforced its commitment to holding short-term interest rates near zero until “well past the time that the unemployment rate declines below 6.5 percent.” It’s now 7 percent.

Voting for the Fed move to trim its bond buying program was Esther George, president of the Kansas City Fed, who has dissented at each previous Fed meeting this year because the bond buying had not been reduced.

The Fed shift signaled that it sees the economy and particularly the jobs outlook at a turning point.

The 7 percent jobless rate marks a five-year low thanks partly to four months of steady hiring. Factory output has risen. Housing starts and home prices are climbing. Consumers are spending more, giving the auto industry its best sales year since the recession ended.

After the Fed announcement Wednesday, the Dow Jones industrial average soared, closing up 292.71 to a record 16,167.97. Its already stellar gain for the year grew to 23.4 percent.

Bonds fared less well. Their prices slipped and drove up interest rates on 10-year U.S. Treasury bonds to their highest in nearly two weeks. Bond rates and prices move in opposite directions.

Bond interest rates had climbed earlier this year when the Fed first talked about possibly slowing its bond purchases. The talk drove mortgage rates about a percent higher too.

Wednesday’s muted reaction in interest rates showed that the market had prepared for a Fed move soon, though not necessarily now.

“It seemed inevitable, and it was time to pull the trigger,” investment manager Richard Schlanger at Pioneer Investments said of the Fed’s decision.

Not everyone involved in the decision thought so.

Eric Rosengren, president of the Boston Federal Reserve Bank, dissented from the cutback in bond buying, saying it was “premature until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate.”

Analysts expect further cutbacks in the bond program at future Fed meetings.

The Fed emphasized Wednesday that it was not kicking away the crutch.

Further cutbacks will depend on how the economy and jobs outlook fare. Chairman Ben Bernanke said in a news conference that the Fed could “skip a meeting or two” in cutting back purchases further if the economy shows weakness. He said cutbacks could come faster if the recovery does too.

Dan Heckman, fixed income strategist at U.S. Bank, said: “The economy can continue to improve. They’re going to make sure that it does.”

In running its bond buying program, the Fed had said it would take its cue from improvements in the jobs outlook specifically. On Wednesday, it forecast gains ahead.

Unemployment will dip as low as 6.3 percent next year and 5.8 percent in 2015, its forecasts said. Unemployment has fallen faster than the Fed’s previous forecasts predicted.

The Fed also said inflation, now below its target of 2 percent, will guide its decisions. Policymakers are concerned that the economy would suffer anew should inflation drop so low as to turn into a deflation, when prices decline. Its efforts, including buying bonds, aim partly to avoid a deflation.

“There is still this question about inflation, which is more than a bit of concern,” Bernanke said. “We are committed to doing what is necessary to getting inflation back to target.”

Bernanke is leaving the Fed at the end of January and is expected to be replaced by vice chairwoman Janet Yellen. At the news conference, Bernanke said that Yellen “fully supports what we did today” and that they had consulted closely.

The Associated Press and Bloomberg contributed to this report.

To reach Mark Davis, call 816-234-4372 or send email to mdavis@kcstar.com.

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