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Economic Update

 
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Fed Ushers in New Era: Asset Purchases Reduced, Forward Guidance Strengthened

December 18, 2013

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  • Fed ushers in new era: asset purchases reduced, forward guidance strengthened

Not to be outdone in the news-making department by the impending Congressional agreement on the budget, the Federal Reserve announced on Wednesday a $10 billion per month reduction in asset purchases to $75 billion from $85 billion, commencing in January 2014.  We previewed this outcome in our commentary last Friday.

Boston Fed President Eric Rosengren cast the only dissenting vote, noting that the unemployment rate is still elevated and inflation is well below the Fed’s target rate. 

Key points from today’s decision:

  1. The monthly reduction of asset purchases is modest ($10 billion), and the Federal Open Market Committee (FOMC) decided to reduce purchases of Treasuries and mortgage-backed securities by $5 billion apiece, putting the totals at $40 billion and $35 billion, respectively.  This pace is not fixed, and the Fed stands ready to change the size of asset purchases depending on incoming economic data.

    When questioned on this front during his news conference, Chairman Ben Bernanke suggested that similarly sized reductions might be expected from future meetings if economic conditions continue to improve at their recent pace.  This would bring asset purchases to a close in late summer 2014.
     
  2. Although the Fed has reduced the support it will provide, the Fed strengthened its forward guidance by pledging to maintain the current target for the federal funds rate “well past the time” that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below 2.0%.
     
  3. The Fed largely maintained the outlook for economic growth it published last September.  Real gross domestic product (GDP) is projected to grow between 2.8% and 3.2% in 2014.

  4. The unemployment rate is projected to decline to 6.6% by the end of 2014, a small reduction from the prior forecast.  In remarks following the meeting, Chairman Bernanke encouraged viewing labor market conditions beyond the unemployment rate to get a more complete picture. 

  5. The Fed remains significantly concerned about inflation, which is reflected in the emphasis in the forward guidance.  The Fed predicts contained inflation throughout the entire forecast period.  The Fed believes that several special factors, such as the deceleration of health care costs, will be reversed as economic growth advances. 


  6. Except for three of its members, the FOMC expects a higher federal funds rate in 2015. Only two would prefer a higher federal funds rate in 2014. 

The U.S. bond market, for the most part, shrugged off the decision, with yields hardly budging after the announcement.  Equity prices rallied, mostly as a vote of confidence on the Fed’s statement about the cumulative progress that has occurred in the economy.  Clearly, efforts have succeeded to reduce the shock of monetary policy movements since tapering was first mentioned last May.

The Fed’s indication of "measured steps at future meetings" and "no preset course" are key factors to guide markets in assessing the Fed’s next step.  Inflation readings will be critical, as will the labor market indicators.  New members of the FOMC in 2014 and a new Fed chairperson are additional nuances we’ll all have to consider.
But the long journey to normalize monetary policy had to begin with a first step, and we think it was very appropriate to take such a step at this time.

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The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
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