WASHINGTON — The Federal Reserve announced Wednesday the beginning of the end for a controversial bond-buying program in support of the U.S. economy, a signal of an improving recovery that sent stocks soaring at the close of trading.
Starting in January, the Fed will begin tapering back by $10 billion a month its $85 billion a month in bond-buying that began in December 2012. Fed Chairman Ben Bernanke said that the taper could continue with each successive meeting.
“My expectation is for similar moderate steps going forward throughout most of 2014,” Bernanke said, cautioning, “I want to emphasize that we are going to be data-dependent.”
In addition to the announcement that it would take its foot off the accelerator, the Fed also issued new guidance for when, and under what conditions, it might begin to raise its benchmark interest rate that influences borrowing costs in the economy. The short answer is not anytime soon.
“It’s a dovish taper,” said Mark Zandi, chief economist for forecaster Moody’s Analytics, adding that the Fed effectively backed away from its earlier target of an unemployment rate of 6.5 percent as a milepost for when interest rates might rise in the economy. “The Fed is on track to end (stimulus) by the fall of 2014 and begin raising interest rates by the fall of 2015.”
Bernanke’s guidance suggested the Fed wants to go “well past” the time the unemployment rate, now at 7 percent, reaches 6.5 percent. That’s something most Fed members think could happen late next year. Three members, he said, didn’t expect interest rates to begin their first climb until 2016.
Those developments sent glee across Wall Street, among the biggest benefactors of the Fed’s stimulus efforts. The Dow Jones industrial average closed up 292.71 points to 16,167.97; the Standard & Poor’s 500 index followed suit, rising 29.65 points to 1,810.65. The tech-heavy Nasdaq composite index rose 46.38 points to 4,070.06.
The purchases of government and mortgage bonds were designed to spark more risk taking and thus more activity in the economy. The idea is that the purchases of safe bonds drive down their return to investors, making riskier assets like stocks more attractive.
Bernanke, who steps down Jan. 31 after eight years at the helm, said the effort called quantitative easing has helped lower long-term lending rates and thus create jobs. He also said Wednesday’s decision was made with full support from the Obama administration’s designated successor, current Fed Vice Chairman Janet Yellen.
“I have always consulted closely with Janet, even before she was named by the president, she fully supports what we did today,” said the Fed chief. Yellen is awaiting confirmation by the full Senate.
Improving conditions in the housing and labor markets and an improving economy were cited as reasons by the Fed to “modestly reduce the pace of “asset purchases.” But Bernanke warned that asset purchases are not on a “preset course,” a reminder that it could speed up the removal of stimulus or go back to it as conditions warrant.
While easing the stimulus, the Fed isn’t completely removing support. In addition to buying $75 billion a month in bonds, it’s also buying bonds by reinvesting principal payments from its holdings.
“The committee’s sizeable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative,” the Fed statement said.
Wednesday’s move was somewhat of a surprise as inflation remains below the Fed’s target of 1-2 percent, and the stimulus was designed in part to actually spark a little inflation through more economic activity.
“The committee is determined to avoid inflation that is too low,” Bernanke said, vowing that his successor would surely take steps like reinstating stimulus efforts to ensure that inflation stays in the target range. The annual rate of inflation in 2013 is expected to be about 0.9 percent, he said, increasing to about 1.7 percent in 2014.