Fed will cut bond purchases by $10B in January

Paul Davidson | USA TODAY

Show Caption Hide Caption Fed to reduce bond purchases by $10B The Federal Reserve has decided to reduce its stimulus for the U.S. economy because the job market has shown steady improvement. (Dec. 18)

Fed will buy %2475B a month in government bonds%2C down from %2485B

Reduces purchases of both Treasury bonds and mortgage-backed securities

Key interest rate likely to remain low %22well past%22 jobless rate%27s decline to 6.5%25

The Federal Reserve said Wednesday it will modestly pare back its extraordinary easy-money program, citing recent momentum in the economy and job market.

It marks the first big step toward unwinding the massive stimulus the Fed has pumped into the economy since the 2008 financial crisis and Great Recession.

"We expect economic growth to be strong enough to support further job gains," Fed Chairman Ben Bernanke told reporters after a two-day Fed meeting. He added that Fed policymakers are hopeful of soon seeing "the whites of the eyes of the end of the recovery" and the beginning of more normal economic growth.

In a statement after a two-day meeting, the Fed said, that starting in January, it will buy $75 billion a month in government bonds, down from $85 billion a month since October 2012. The Fed will purchase $40 billion in Treasury bonds, down from $45 billion previously, and $35 billion in mortgage-backed securities, down from $40 billion. The purchases are intended to hold down interest rates and spur economic and job growth.

Fed policymakers said they would likely continue to trim the purchases "in further measured steps at future meetings." But they added the purchases "are not on a preset course" and they could adjust the pace based on the labor market outlook, inflation and the program's risks.

Since the Fed began the bond purchases in September 2012, the jobless rate has fallen to 7% last month from 8.1% and employers have added nearly 3 million jobs.

Boston Fed President Eric Rosengren was the lone dissenter. With unemployment still elevated and inflation well below the Fed's target, Rosengren believes that tapering "is premature until incoming data more clearly indicate that economic growth is likely to be sustained above its potential rate," the statement said.

Bernanke acknowledged that the recovery "has much farther to travel," with unemployment still near record levels. Inflation, he added, is running well below the Fed's 2% annual target, the hallmark of a sluggish recovery.

Partly because of the lingering concerns, many economists expected that, along with tapering, the Fed would lower its unemployment threshold for how long it will keep its benchmark short-term interest rate near zero from 6.5% to 6%. That would stress that tapering does not signal an earlier rise in short-term rates.

Although the Fed did not formally lower the threshold, it added that it expects to keep the benchmark rate near zero "well past the time that the unemployment rate declines below" 6.5%, especially if projected inflation continues to run below" the Fed's target.

Bernanke also stressed the Fed is not withdrawing stimulus but simply slowing the flow of easy money. If the economy or job market slows, "we could skip the meeting" and keep the bond purchases at existing levels, he added.

The Fed slightly upgraded its economic outlook. It now expects the economy to grow at a 2.2% to 2.3% annual rate this year, up from its September forecast of 2% to 2.3%. It predicts the economy will grow 2.8% to 3.2% in 2014, vs. its previous projection of 2.9% to 3.1%.

The unemployment rate is projected to fall to 6.3% to 6.6% by the end of next year, lower than its previous forecast of 6.4% to 6.8%. The Fed expects the jobless rate to be 5.8% to 6.1% by the end of 2015.

Just a handful of the 34 economists USA TODAY surveyed last week predicted the Fed would reduce the bond purchases this week, but a slight majority said the tapering would begin by January, while many others picked March.

The question of when the Fed will begin to trim the purchases has transfixed Wall Street for months. The Feds stunned financial markets in September by putting off the tapering amid weaker economic data and stood pat again in October. But the odds of the Fed acting in December rose recently as reports showed a strengthening economy.

Monthly job growth has averaged a solid 200,000 the past four months despite the federal government shutdown. In November, housing starts increased at the fastest pace in nearly six years and manufacturing output posted its strongest growth since late 2012.

Congress is poised to pass a two-year budget deal that would alleviate uncertainty among businesses over tax and spending policy.

At the same time, inflation has been running well below normal, theoretically giving the Fed more flexibility to keep the stimulus going and await more signs that the economy will continue to improve.

Since September 2012, the Fed each month has purchased $45 billion in Treasuries and $40 billion in mortgage-backed securities to push down long-term interest rates and stimulate more home and car purchases and business investment. The low rates also have driven investments to riskier assets, fueling a stock market rally.

But Fed policymakers have grown increasingly concerned about the risks of the bond-buying, such as eventual high inflation and the formation of bubbles in real estate, junk bonds and other assets.

Since the Fed began signaling in May that it may soon begin to dial down the purchases, interest rates have drifted higher, with the average 30-year fixed mortgage rate rising to 4.42% from 3.35% in May. The rising rates helped convince the Fed to delay tapering in September.

Further complicating the picture is that Fed Chairman Ben Bernanke plans to step down when his term ends in January. Vice Chair Janet Yellen, who has been nominated to succeed him, has expressed an even more pro-growth approach but must deal with a policymaking committee with diverse views of the stimulus.