The U.S. Federal Reserve has decided to taper its bond-buying program by another $10 billion US, to $65 billion a month, beginning in February.
The move underscores the U.S. central bank’s confidence in an economic recovery despite recent volatility in stock markets.
In his last meeting as chairman of the Fed's powerful open market committee, Ben Bernanke agreed to a second tapering, following on a Dec. 18 decision to cut monthly asset purchases to $75 billion a month in January.
Today's announcement continues the tapering process begun at the start of the year.
"Beginning in February, the committee will add to its holdings of agency mortgage-backed securities at a pace of $30 billion per month rather than $35 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $35 billion per month rather than $40 billion per month," the Fed said in its statement this afternoon.
Signs of recovery
The committee said its indicators show that growth in economic activity has picked up, with household spending and business investment advancing more quickly.
The Fed expressed concern about the unemployment rate and lack of inflation in the U.S. and reiterated that rates could remain low until there are further signs of strength.
“The committee ... reaffirmed its expectation that the current exceptionally low target range for the federal funds rate of 0 to .25 percent will be appropriate at least as long as the unemployment rate remains above 6.5 per cent, inflation between one and two years ahead is projected to be no more than a half percentage point above the committee's two per cent longer-run goal, and longer-term inflation expectations continue to be well anchored,” the statement said.
In January, both the IMF and the World Economic Forum gave upbeat outlooks on the U.S. economy, saying it could grow by 2.8 per cent this year.
After the Dec. 18 decision to cut the monthly asset purchases, Bernanke promised "further measured steps at future meetings."
Guidance on rates
The Fed also extended its timeline for zero interest rates at that meeting, in an attempt to calm investors who might react negatively to the prospect of rising rates. Today's cautionary note on the low target for rates is meant to reaffirm that message.
Stocks in New York and Toronto, which were lower ahead of the announcement, took a deeper dip after the Fed release at 2 p.m. ET and recovered slightly later in the session.
The S&P/TSX composite index dropped 44.44 points to 13,643.22 and the Canadian dollar closed down 0.18 of a cent to 89.46 cents US.
The Dow Jones industrials tumbled 189.77 points to 15,738.79, the Nasdaq composite index lost 46.53 points to 4,051.43 and the S&P 500 index finished 18.3 points lower at 1,774.2.
Michael Gregory, deputy chief economist at BMO, says the liquidity provided by the Fed bond-buying program was a “drug” that financial markets have gotten used to. The gyrating stock prices reflect a change in perception by traders, he said.
“Investors are coming to terms with [the idea that] if stock prices are going to go up — if investments are going to be made — it’s going to be made on the merits of those investments, on the merits of the companies that you’re buying, not on the fact that the Fed is going to be providing endless amounts of liquidity,” he said.
In January, the taper acted to reinforce perceptions that the U.S. economy is on the mend, with money flowing out of emerging market currencies towards the U.S. dollar, causing market volatility in the past week.
Martin Schwerdtfeger, senior economist with TD Economics, said the Fed appeared to pay little attention to the turmoil around emerging market currencies. That may be because U.S. bond yields dropped as investors poured money into U.S. assets, he said.
Challenge for Yellen
“If anything, the sell-off observed in recent weeks across emerging markets has contributed to bring down U.S. Treasury yields, which are now 30 basis points lower than at the end of last year. This gave the Fed even more room to proceed with tapering, as – on the margin – domestic financial conditions have turned more accommodative,” he said in a note to investors.
The Fed is widely believed to be on course to taper monthly throughout 2014.
As Janet Yellen prepares to step into the role of Fed chair, she has a wary eye on U.S. job-creation figures, which were far from stellar in December, just 74,000 jobs created in the wake of the federal shutdown in October. However, the national unemployment rate fell to 6.7 per cent, the lowest in more than five years, with some states experiencing a steep drop in jobless claims.
Yellen must also be prepared to wrestle with how to handle the estimated $4 trillion in bonds the Fed has bought in its stimulus plan.