Thursday, December 19, 2013

Fed Takes Action

As the economy has grown stronger, the Federal Reserve has been discussing when to reduce its bond and mortgage purchases. For about 15 months, the Fed has been purchasing about $85 billion each month and has acquired approximately $3 trillion in these investments. The purpose was to add liquidity to the economy, which resulted in lower mortgage interest rates, lower long-term bond interest rates and a booming stock market. The Fed indicated this afternoon that they will taper off these purchases by about $10 billion, bringing them down to about $75 billion monthly. Tapering will reduce the flow of cash from the Fed but will also allow them to adjust upward easily if the economy shows signs of souring. If tapering does not disturb the economy, it will likely be followed by additional cuts until all purchases are stopped. The long-term impact of this change will likely be an increase in longer-term interest rates and slowing of the rise in stock prices.  I had not personally expected the change until March of 2014, once Janet Yellen was in place as the new Fed Chairman. The change is likely to be the last major action by the current Fed Chief, Ben Bernanke. At the same time that they announced the tapering of purchases, the Fed also indicated that short-term rates would remain close to zero until after the unemployment rate goes below 6.5%.  This information means that short-term rates will be likely to stay at zero until late 2015 or early 2016.

Ed Mallon