Here’s why everyone seems relieved by the Fed’s January taper

“Everyone was focusing on the wrong animal, they were betting on whether the Fed is hawkish or dovish, but they missed the fact that the Fed is bullish on the economy,” Burt White, chief investment officer at LPL Financial told Marketwatch.com.

I love that statement. It’s brilliant because it perfectly sums up the reasoning behind the Fed’s widely-anticipated decision to taper its bond-buying programme from January.

To be sure, the last policy review of the Federal Reserve for 2013  — and chairman Ben Bernanke’s last press conference before he steps down at the end of January next year – did not disappoint.

In a statement,the Federal Reserve announced that would taper (reduce) its $85 billion a month bond-buying programme by $10 billion from January. The central would shave $5 billion off its mortgage-backed securities purchases and another $5 billion from its Treasury securities purchases.

It was the decision investors around the world had been waiting for since May. Finally, the taper has officially been set in motion.

US stocks soared to record highs and the dollar jumped to its highest 2013 level against the yen as a few points became apparent from the statement:

One, the Fed is undertaking tapering because it is quite optimistic about the prospects of the US economy going ahead.

“The Committee sees the risks to the outlook for the economy and the labor market as having become more nearly balanced,” the statement said.

“Information received since the Federal Open Market Committee met in October indicates that economic activity is expanding at a moderate pace. Labor market conditions have shown further improvement; the unemployment rate has declined but remains elevated.

“Household spending and business fixed investment advanced, while the recovery in the housing sector slowed somewhat in recent months. Fiscal policy is restraining economic growth, although the extent of restraint may be diminishing.”

Two, the monetary policy stance will continue being easy for some time to come, never mind the start of tapering.

“The Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens,” it noted.

Three, an unemployment rate of 6.5% will not trigger higher interest rates for the US economy. The pace of inflation will also be considered before policy rates are hiked. With the unemployment rate at 7%, some investors had been fretting about an interest rate hike if the jobless level fell to 6.5% in coming months, as suggested by on earlier Fed statements.

The Fed has now committed to keep interest rates lower for longer.

“The Committee now anticipates…that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.

“When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent,” it added.

Four, there is no predefined taper timetable, although Bernanke did point out that if everything goes according to plan, the bond-buying programme would be shuttered by the end of 2014.

Nevertheless, the Fed is keeping open the option to change direction if required. “ If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings,” it said

“However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases.”

Five, inflation will become a key factor in policy decisions going ahead. “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.”

In a nutshell, the Fed started dialling back its monetary stimulus, but offered strong forward guidance on what will guide policy action going forward. It also gave a cautious thumbs-up to the state of the US economy.

And investors liked that. A day after the Fed’s announcement, global stock markets climbed higher.

As one expert told Associated Press: “The Fed’s decision removes a huge amount of uncertainty for investors, something they hate. The fate of the stimulus program had hung over investors’ heads since May. Now that investors have an outline for how the Fed will pull back, they can move forward.”

Quartz (a digital-only news website) also summed up investor reaction pretty nicely: “Even though the Fed announced the taper, its focus on low inflation suggests that it will continue to be a large presence in the markets for some time to come. Stock market investors seem to like the sound of that.”

They certainly d0.

[Image Credit]

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