- The Washington Times - Wednesday, January 29, 2014

The Federal Reserve on Wednesday shook global markets, cutting back once again on its economic stimulus program and signaling that a recent softening of job gains and turmoil in emerging markets will not deter it from ending its extraordinary easing measures this year.

The move was outgoing Chairman Ben S. Bernanke’s last official act as the head of the Fed’s interest-rate setting committee, with Vice Chair Janet Yellen set to take over Feb. 1. Mr. Bernanke led a unanimous vote to pare back the Fed’s monthly Treasury and mortgage bond purchases by another $10 billion to $65 billion, continuing a pace of “tapering” that sets the central bank on course to fully withdraw from the long-term bond markets by the end of the year.

Though the move was widely expected, Wall Street markets — which have been fragile since last week’s turmoil in major emerging markets — reacted badly, with the Dow Jones industrial average falling over 200 points after the Fed’s afternoon announcement. The Dow ended down 190 points at 15,739, with all major U.S. stock indexes losing more than 1 percent of their value.

Stocks, bonds and currencies from Turkey to Tokyo and Brazil to Mumbai have been in decline, in part out of concern that the gradual withdrawal of the Fed’s easy-money policies portends the end of ultra-low global interest rates — a development that hits faltering emerging markets with large debts like Argentina and India particularly hard.

The Fed’s statement gave no indication that the central bank took the market turmoil into consideration in deciding to go ahead with its gradual tightening.

The Fed cited underlying strength in the U.S. economy as its reason to ease up its stimulus efforts. In focusing on signs of strength, the Fed also downplayed recent economic reports that showed sudden weakness in job growth and big-ticket purchases in December. While some economic news has been mixed, it said, the only major factor significantly holding back the economy is federal budget austerity, which caused a sharp weakening of defense capital goods orders recently.

“Information received since … December indicates that growth in economic activity picked up in recent quarters,” the Fed statement said. “Labor market indicators were mixed but on balance showed further improvement. The unemployment rate declined but remains elevated.”

Joseph Lake, U.S. analyst at the Economist Intelligence Unit, said the Fed was right to ignore frenzied markets and the occasional soft economic report to focus on signs that the underlying economy is gaining momentum.

“If the Fed changed its stance for every slight bump in the economy, it would weaken its policy signal and damage its credibility,” he said.

The Fed also should not concern itself unduly with the turmoil in emerging markets, he said, in particular because it is actually aiding U.S. consumers by lowering U.S. interest rates as investors worldwide dive into U.S. Treasury securities as a safe haven from the storm. The yield on Treasury’s 10-year bond fell below 2.7 percent Wednesday after having risen to over 3 percent before the market downturn started last week.

That means the rates on 30-year mortgages and other long-term loans are likely to tick down in coming days despite the Fed’s move to withdraw support from the markets.

“American consumers may actually benefit from the recent jitters in global markets,” and that likely pleases the Fed while making its jobs a little easier, Mr. Lake said.

Michael Gapen, analyst at Barclays, said the Fed is not worried about an occasional 200-point or 300-point drop in the Dow. “The type of volatility seen in recent weeks is insufficient to cause the committee to alter its policy stance, particularly so soon after tapering began,” he said.

Rick Rieder, fixed income analyst at BlackRock, said the Fed had to keep ratcheting down the easing program primarily because it has done little to improve the job market, which was the Fed’s original goal in launching the program in September 2012. Although the unemployment rate has dropped from over 8 percent to 6.7 percent since the program began, the pace of job growth has remained largely the same at about 170,000 jobs a month — a development the Fed acknowledges is disappointing.

“The program has outlived its usefulness,” Mr. Rieder said. “Continuing the removal of [quantitative easing], even in the face of weaker economic data and higher market volatility, is an action we can applaud.”

“While it’s an effective tool for stabilizing financial conditions, the policy has largely proven ineffective at achieving its primary goal of strengthening anemic labor markets,” he said. “We think labor market gains are more likely to come from strengthening economic growth over time.”

The analyst said the Fed likely is more concerned about market and economic conditions overseas than it lets on, since weak growth in Europe, Japan and big emerging nations like China and Brazil that are important trading partners can dim the prospects for better growth in the United States as well.

“The central bank could well be influenced by dynamics outside the borders of the United States” as it continues to withdraw support for markets in the months ahead, he said. “They all hold an influence on the U.S.’s own growth trajectory.”

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