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Fed cuts bond buying in 1st step away from historic stimulus

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[December 19, 2013]  By Jonathan Spicer and Jason Lange

WASHINGTON (Reuters)  The Federal Reserve on Wednesday embarked on the risky task of winding down the era of easy money, saying the U.S. economy was finally strong enough for it to start scaling down its massive bond-buying stimulus.

The central bank modestly trimmed the pace of its monthly asset purchases, by $10 billion to $75 billion, and sought to temper the long-awaited move by suggesting its key interest rate would stay at rock bottom even longer than previously promised.

At his last scheduled news conference as Fed chairman, Ben Bernanke said the purchases would likely be cut at a "measured" pace through much of next year if job gains continued as expected, with the program fully shuttered by late-2014.

The move, which surprised some investors but did not cause the market shock many had feared, was a nod to better prospects for the economy and labor market. It marked a historic turning point for the largest monetary policy experiment ever.

"The recovery clearly remains far from complete," Bernanke said. But "we're hopeful ... we'll begin to see the whites of the eyes of the end of the recovery, and the beginning of the more normal period of economic growth."

Bernanke said he consulted closely on the decision with Fed Vice Chair Janet Yellen, who is set to succeed him once he steps down on January 31 after eight years at the helm. "She fully supports what we did today," he said.


Investors took the action as a validation that the outlook for the economy was improving. After a brief pullback, U.S. stocks rallied sharply, with both S&P 500 and Dow industrials closing at all-time highs.

At the same time, U.S. Treasury bond prices fell, but the move was modest, capped by the Fed's strengthened commitment to keep interest rates near zero for a long time irrespective of the reduction in its asset purchases.

The Fed said monthly purchases of both mortgage and Treasury bonds would be trimmed by $5 billion each, starting in January.

"This is a modest change, not a big one, and it shows that they are not in a rush," said Scott Clemons, chief investment strategist for Brown Brothers Harriman Wealth Management. "The Fed is using very careful language that they are going to continue to support the economy."

END OF AN ERA

The Fed's extraordinary money-printing has helped drive stocks to record highs and sparked sharp gyrations in foreign currencies, including a drop in emerging markets earlier this year as investors anticipated an end to the easing.

"They finally pulled a Band-Aid off that they've been tugging at for a long time," said Rick Meckler, president of hedge fund LibertyView Capital Management in Jersey City, New Jersey.

The Fed launched its third and latest round of quantitative easing, or QE, 15 months ago to kick-start hiring and growth in an economy recovering only slowly from the recession. Its first program was launched during the 2008 financial crisis.

The central bank's asset purchase programs, a centerpiece of its crisis-era policy, have left it holding roughly $4 trillion of bonds, and the path it must follow in dialing it down is rife with numerous risks, including the possibility of higher-than-targeted interest rates and a loss of investor confidence.

To soothe investors' nerves, the Fed said it "likely will be appropriate" to keep overnight rates near zero "well past the time" that the jobless rate falls below 6.5 percent, especially if inflation expectations remain below target.

The Fed has held rates near zero since late 2008.

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It was a noteworthy tweak to an earlier pledge to keep benchmark credit costs steady at least until the jobless rate, which dropped to a five-year low of 7.0 percent in November, hits 6.5 percent.

"The actions today are intended to keep the level of accommodation the same overall," said Bernanke, who held out the prospect of fresh stimulus if the economy stumbled. He said officials could further bolster their low-rate pledge, or even cut the interest rate they pay banks on excess reserves held at the Fed in a bid to spur lending.

EXPECTATIONS ON INFLATION, RATES

In fresh quarterly forecasts, the central bank lowered its expectations for both inflation and unemployment over the next few years, acknowledging the jobless rate had fallen more quickly than expected. It now sees it reaching a range of 6.3 percent to 6.6 percent by the end of 2014, from a previous prediction of 6.4 percent to 6.8 percent.

Three policymakers expect the first rate rise to come in 2016, up from only two in September, while 12 of the Fed's 17 top officials still see the move in 2015. Futures markets do not see better-than-even odds of a rate hike until September 2015.

Critics of the bond buying, including some Fed officials, have worried the program could unleash inflation or fuel hard-to-detect asset price bubbles.

But some have credited the purchases with stabilizing an economy and banking system that had been crippled by the 2008 financial crisis and with staving off what could have been a damaging cycle of deflation.

One policymaker, Eric Rosengren of the Boston Fed, dissented against the decision, which he felt was premature given the still-high unemployment rate.

Bernanke stressed the Fed was not giving up on supporting the economy, and said it would take action if inflation failed to rise to the central bank's 2 percent target. Inflation as measured by the Fed's preferred price gauge rose just 0.7 percent in the 12 months through October.

Even so, recent growth in jobs, retail sales and housing, as well as a fresh budget deal in Congress, had convinced a growing number of economists the Fed would trim the bond purchases.


But many thought the central bank would wait until early in the new year, given persistently low inflation and the fact that the world's largest economy has stumbled several times in its crawl out of the 2007-2009 recession.

(Reporting by Jonathan Spicer and Jason Lange; editing by Krista Hughes, Tim Ahmann and Dan Grebler)

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