Quantitative Easing

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In her first Federal Open Market Committee meeting as head of the Federal Reserve Janet Yellen made good on her promise of continuity, again cutting back the central bank’s asset purchases. On Wednesday, the FOMC announced a third $10 billion reduction to quantitative easing, reducing its monthly bond purchases to $55 billion and keeping with Fed watchers’ tapering exceptions. The Fed will cut monthly mortgage bond purchases to $25 billion from $30 billion. Treasury purchases will drop to $30 billion a month from $35 billion. The stock market initially dropped slightly on the news, off of mixed signals leading up to the 2 p.m. release. Following the release The Dow Jones Industrial Average was down about .2% and the S&P was down close to .5%. The 10-year Treasury note yield climbed to 2.76%. In a press release announcing the reduction, the FOMC wrote, “Information received since the Federal Open Market Committee met in January indicates that growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions. Labor market indicators were mixed but on balance showed further improvement.” Looking ahead the committee reaffirmed its commitment to low interest rates by removing references to a 6.5% unemployment threshold, as expected. The committee wrote, In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” The Fed purchased $85 billion worth of bonds each month of last year as part of its efforts to stimulate the post-recession economy. In December 2013, the FOMC cut monthly asset purchases by $10 billion noting that the economy was moderately expanding. The committee pledged to keep a close watch on economic data but implied that — barring major changes to its outlook — investors should expect small measured cuts at subsequent meetings. At its January meeting, Ben Bernanke’s last, the FOMC cut another $10 billion while maintaining tight control on interest rates. In the weeks following that meeting, some market watchers briefly questioned if the Fed might change course on slightly weaker economic data. Most, however, attributed declines in retail sales and housing starts to unusually cold winter weather. Yellen promised to look into the weather impact, but made no public statements indicating she foresaw changing the course. “At the end of the day we need to listen to what the Fed is saying,” said Heather Loomis, a director of fixed income for JPMorgan Private Bank. Loomis pointed out that quantitative easing was put in place to address weakness in housing and labor markets, as well as lagging consumer confidence. As these areas have improved dramatically “it looks like their work here is done. It is going to takes something bigger to derail their consistent pace of asset purchase reduction.” With further cuts to QE widely viewed as inevitable, economists and investors are turning their attention to forward guidance on interest rates — a separate central bank tool that has often been conflated with tapering. In a phone call prior to the announcement Steve Blitz, chief economist at ITG Investment Research, said Yellen is stuck in a “policy box” that she will need to talk her way out of. In the heat of the economic downturn Bernanke and co announced they would consider raising interest rates when the unemployment rate hit 6.5%. “It was probably pretty easy to talk about that being far down the road when the unemployment rate was at 8%,” said Kathy Jones, fixed income strategist at Schwab, in a phone call. But now that the rate is down to 6.7% the Fed and others are finding that broader...
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