Given the U.S. economy’s growing strength, the Federal Reserve pushed ahead Wednesday with a plan to shrink its bond-buying program, even though the prospect of reduced stimulus and higher interest rates has rattled global markets.
The central bank said it will cut its monthly bond purchases, starting in February, by $10 billion to $65 billion. It also reaffirmed a plan to keep short-term rates at record lows, to try to reassure investors that it will keep supporting an economy that’s stronger than at any point since the recession, yet remains less than fully healthy.
The Fed’s decision came in a statement after the final policy meeting of Ben Bernanke, who will step down Friday after eight years as chairman. He will be succeeded by Vice Chair Janet Yellen.
Most economists expect, that under Yellen, the Fed will announce a string of $10 billion monthly reductions in bond purchases at each meeting this year, concluding with a final $15 billion cut in December. Still, if the American economy were to falter, the Fed has stressed that it might suspend its pullback in bond buying, so it could keep aggressively holding down long-term loan rates.
Many global investors fear that reduced Fed bond buying will raise U.S. interest rates, and cause investors to move money out of emerging markets and into the United States for higher returns. Currency values in emerging economies have fallen over that concern.
In response, central banks in emerging economies, from India to Turkey to South Africa, have been acting to counter any damage from the Fed’s pullback and the prospect of higher U.S. rates. They’ve been raising their own rates, hoping to control inflation, boost their flagging currencies and keep investors from fleeing.
But so far, those currencies have continued to weaken.
The Fed’s bond purchases have been intended to keep long-term borrowing rates low to spur spending and growth. Its decision Wednesday to continue paring purchases, signals the Fed’s belief that the economy is showing consistent improvement. In its statement, it upgraded its assessment to say “growth in economic activity picked up in recent quarters.”
On Thursday, the government will issue its first estimate of economic growth in the October-December quarter. Analysts have estimated that the economy grew at a solid 3.3 percent annual rate last quarter, after an even stronger 4.1 percent annual rate from July through September.
Still, stocks fell after the Fed announced its decision. That was in part because of disappointing earnings from big U.S. companies, and the jitters in emerging markets.
The Dow Jones industrial average closed down 189 points. It had been down 127 points just before the Fed’s announcement. Disappointing earnings from big U.S. companies contributed to a sour mood on Wall Street. The yield on the 10-year Treasury note slipped to 2.68 percent.
Some analysts said the Fed’s confidence in the U.S. economy appeared to outweigh any concern that the turmoil in emerging market economies might spill over into the United States and other developed nations.
“These economies have not been driven into deep recession,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, said of the emerging economies. “Their currencies are weak but not in free fall.”
The Fed made no mention of the turbulence that has rocked markets for the past week. In part, that reflects the Fed’s role as a steward of the U.S. economy, not the global economy. Its dual mandate is to maximize U.S. employment and keep U.S. prices stable.
Inflation remains historically low. Consumer prices rose just 1.5 percent in 2013, below the Fed’s target of 2 percent. Fed officials said in their statement Wednesday that they are watching inflation closely to ensure it doesn’t fall too far. Among other concerns, ultra-low inflation raises inflation-adjusted interest rates, making it harder to pay off debts and potentially discouraging borrowing.
The Fed’s bond purchases have helped fuel a huge stock market rally over the past year as investors shifted money out of low-yielding bonds and into stocks. Now that the Fed is cutting back on those bond purchases, many investors fear stocks will fall.
“Ultimately, the Fed sort of had no choice but to reduce purchases at this meeting,” said Dan Greenhaus, chief strategist at BTIG brokerage. “If they had paused, they risked sending a signal to markets that they lacked conviction.”
The action Wednesday was approved on a 10-0 vote. The last time a Fed policy statement was approved unanimously was June 2011.
The Fed’s statement repeated a phrase it first used in December: The bank would hold its benchmark short-term rate near zero “well past” the time unemployment falls below 6.5 percent. The Fed noted that government spending cuts and tax increases are less of a drag on growth than last year. It also said businesses and consumers are stepping up spending.
The unemployment rate dipped from 7 percent to 6.7 percent in December, the lowest point in five years. Still, much of the decline was due to an exodus of job seekers who gave up looking for work and were no longer counted as unemployed.