Having decided that economic conditions have improved enough, the Federal Reserve on Wednesday announced that it will start scaling back its $85-billion-a-month bond-buying program in January, defying economist and investor expectations that it would maintain the program well into 2014.
The Federal Open Market Committee (FOMC) said it would trim the bond-buying program – which began in 2012 as a measure to stimulate the economy – by $10 billion to $75 million. Specifically it will cut its purchases of long-term Treasury bonds by $5 billion to $40 billion per month, and reduce its purchases of mortgage-backed securities by $5 billion to $35 billion per month.
FOMC members say they believe the economy and the job market have improved enough to warrant the slight decrease in monetary stimulus, however they warned that the unemployment rate ‘remains elevated’ at around 7.1%.
In June, Federal Reserve Chairman Ben Bernanke – who will retire from his Fed Chair role come January, to be succeeded by incoming chair Janet Yellen – said he didn't expect the Fed to start tapering until the unemployment rate fell below 7%. However, at that time, he indicated that tapering could start as soon as September – an announcement that sent the markets into a tailspin and mortgage interest rates on the rise.
The Fed, in its most recent announcement, noted that the housing sector has slowed in recent months, due mainly to rising rates, and that short-term budget cutting efforts from Congress have also slowed the recovery.
The Fed stressed that it may adjust its bond purchases in the future either upwards or downwards, depending on economic conditions.
‘The committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability,’ the FOMC says in its statement on monetary policy, which is based on its meeting in October. ‘If incoming information broadly supports the committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.’
In another important matter, the committee said it would likely keep the short-term rate near zero well past when unemployment dips below 6.5%, especially if inflation remains near flat, as it has been for the past several months. The central bank had earlier set 6.5% unemployment as the threshold at which it would start considering raising rates. Short-term rates have been pinned near zero since late 2008, as the Fed has sought to keep interest rates low in order to stimulate borrowing.
As per a Wall Street Journal report, 12 of 17 Fed officials said they expect the central bank's benchmark interest rate, called the fed funds rate, to be at or below 1% by the end of 2015. Ten of 17 officials expected the rate to be at or below 2% by the end of 2016.
To access the FOMC's full statement, click here.