Research and Statistics

Fed starts ‘taper,’ begins weaning off support for low rates


The Federal Reserve voted to pump less cash into low long-term rates, but held steady the short-term rates that set credit card APRs

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The Federal Reserve voted Wednesday to start weaning the economy off special economic stimulus measures, marking a post-recession turning point in the direction of rising interest rates.

Noting a warming trend in the economy, the Federal Open Market Committee decided to begin slowing the flow of money it pumps into long-term bonds, from $85 billion a month to $75 billion. The Fed has been buying a mix of housing-backed bonds and Treasury bonds at the $85 billion rate since December 2012.

“In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases,” the FOMC statement said, as the committee wrapped up a two-day meeting. It said it will continue to reduce the purchases moderately at future meetings.

The move reduces support for low long-term interest rates that affect home mortgages. However, the Fed’s lever on short-term rates — which determine credit card APRs  — remains untouched. The federal funds rate target remained pegged at a range of 0 percent to 0.25 percent, and analysts expect it to remain frozen at those low levels for about two years. Variable card rates are pegged to banks’ prime rates, which move in step with the federal funds rate.

The Fed strengthened its commitment to near-zero short-term rates, saying it doesn’t expect to touch the federal funds rate until “well past the time” unemployment falls below 6.5 percent, especially if inflation remains low. At that threshold the committee will begin to look at other workforce measures such as wages, hiring and long-term unemployment, Bernanke said in a news conference following the FOMC announcement.

“I suspect it will be some time after we get to 6.5 percent that all of the other variables we’re looking at line up to give us confidence,” he said. The majority of FOMC members predict that higher short-term rates will begin sometime in 2015, according to projections released Wednesday. The current ultralow rates were set in 2008.

The Fed’s summary of economic projections released Wednesday shows little change in confidence about the economy’s return to more robust health. The core projections include real GDP growth of 2.8 percent to 3.2 percent in 2014, compared to a range of 2.9 percent to 3.1 percent in September, when the Fed last made projections. Expectations for job growth were more sanguine, as the consensus prediction for unemployment in 2014 fell to 6.3 percent to 6.6 percent, from 6.4 percent to 6.8 percent.

The step toward tighter money comes both sooner and later than analysts had expected. Economists widely predicted the FOMC would begin to slow bond purchases at its September meeting. But the committee at that meeting decided to stand pat, citing tepid job growth, an increase in mortgage rates and across-the-board federal spending cuts that pulled money out of the economy. After the committee held the line in October as well, many observers expected that the taper wouldn’t begin until next year, following the expiration of Chairman Benjamin Bernanke’s current term, in order to give his expected successor more latitude to set the new course.

In recent weeks, however, the economy’s vital signs have climbed the charts significantly. The job market turned in a strong showing in November, creating 200,000-plus jobs and reducing the unemployment rate to 7 percent — the level where Bernanke has previously said that bond purchases could decline. Regions Bank Chief Economist Richard Moody called it “a solid report, showing the labor market recovery remains on course, though with further to go still.”

The outlook also improved in Washington, with a bipartisan budget agreement apparently on track to win final approval in both houses of Congress, allaying fears of another government shutdown. However, not all is quiet on the fiscal front, as a fight over the national debt limit continues to shape up for some time in early 2014.

“Less drag from fiscal policy gives the Federal Reserve room to taper asset purchases,” TD Economics said in its analysis.

Inflation remains out of step with the upward march of other economic measures. While low inflation may not sound like a problem to consumers, the current ultralow levels are taken as a sign the economy is cruising at near-stall speed. The Consumer Price Index was unchanged during November, for a year-over-year increase of 1.2 percent. The Fed’s long-term goal is 2.0 percent inflation, which leaves room to hold rates low for some time to come. The committee said it is “monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.”

Wednesday marked Bernanke’s last scheduled FOMC meeting as  Fed chairman, as his current term expires in January. He was appointed by President George W. Bush in 2006 and re-upped under President Barack Obama in 2010. Fed Vice Chair Janet Yellen is on track for Senate confirmation to replace him.

Bernanke helmed the Fed during the financial crisis following Lehman Brothers’ bankruptcy in 2008 and the Great Recession that followed. On his watch as the U.S. commander-in-chief of interest rates, the Fed has taken unprecedented measures to pull the economy back from the brink and restore it to health, expanding the Fed’s balance sheet to $3 trillion. Critics say that shedding that amount will be difficult, and wrenching changes could be in store as the economy tries to kick the stimulus habit. Richard Fisher, president of the Dallas Fed and a critic of the bond-buying policy, said during a speech in June that it may be causing “excessive speculation and risk-taking.”

Bernanke stood behind the policy at the last news conference of his tenure, saying that high unemployment causes  a hit to the nation’s productivity as well as to the lives of unemployed and underemployed workers.

“It’s important to note,” he said of the taper, “even after this reduction, we will still be expanding our holdings of longer-term securities at a rapid pace.”

Asked what he thought economic historians will say about his eight-year tenure, Bernanke responded that the Fed’s tools — bond purchases and promises of low future interest rates — “are not entirely new.” But the post-recession period marks “one of the first examples of aggressive monetary policy taking place in a near-zero interest rate environment.”

He also said that he was around for the cleanup of the housing bubble, not its creation. “By the time I became chairman it was already 2006; house prices were already declining, most of the mortgages had already been made.”

See earlier story:Fed keeps its foot on the gas

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