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In Surprise, Fed Says No QE Tapering

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The Federal Reserve’s policymakers announced Wednesday that the Fed will not start winding down its $85 billion monthly bond-buying program.

Noting that the U.S. economy continues to expand at a “moderate” pace, the Federal Open Market Committee (FOMC) said in its announcement that it has decided nevertheless to continue buying additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.

“Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases,” the FOMC said in a statement after concluding a two-day meeting.

Fed Chief Ben Bernanke. (Photo: AP)Fed Chairman Ben Bernanke (left) said in a press conference following the announcement that the decision to hold off on tapering came as the FOMC witnessed signs of bond market tightening since its June meeting.

With the fed funds rate expected to remain at 1% for the foreseeable future, he said, the FOMC will make no change to forward guidance while maintaining its third round of quantitative easing at current levels.

“The committee is continuing its highly accommodative policy,” Bernanke said during a press conference where reporters peppered him with questions about the recent increase in bond market yields.

In response, Bernanke said “the committee has some concern if conditions tighten further,” and he stressed that U.S. economic growth has generally been proceeding at a moderate pace, even though the unemployment rate stands at unacceptable levels and inflation remains below the desired rate of 2%.

After the FOMC announcement, the benchmark 10-year Treasury note rose 24/32 in price, yielding 2.764% versus 2.861% in early trading on Wednesday. Treasury yields have steadily trended upward since early May, when the 10-year note’s yield rose from 1.61% on May 1 and briefly crossed the 3% mark earlier in September. Stocks rose sharply after the announcement, with the Dow Jones industrial average closing up 0.95% and S&P 500 rising more than 1.22%.

“The Fed surprised markets by holding off on tapering. Bond yields have dropped and the equity market has rallied to new highs on the news,” wrote Jim O’Sullivan, chief U.S. economist with High Frequency Economics in Valhalla, N.Y., in an analyst note following the announcement. “The implication is that tapering will probably start soon, but they are not ready to make the move yet.”

The FOMC announced its third round of bond buying, also known as quantitative easing (QE), a year ago. Since last September, the central bank has pumped about $800 billion into the bond markets in its attempt to stimulate investment in the economy while keeping interest rates down.

Speculation was rife in the days leading up to the FOMC meeting that the Fed would begin to taper its stimulus program.

PIMCO Chief Executive Mohamed El-Erian, for example, told CNBC on Monday that he expected a drop of about $10 to $15 billion in the level of the government’s monthly asset purchases. “They’ll taper small to begin with, but they will taper,” El-Erian predicted, adding that the Fed would likely give itself “quite a bit of wiggle room” while strengthening forward guidance in order to minimize market volatility.

Read PIMCO’s El-Erian Asks: What’s Happening to Bonds and Why? at ThinkAdvisor.


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