(Reuters) – The Federal Reserve started its long-awaited reduction in stimulus, cutting its monthly purchases to $75 billion a month, saying it expects to keep reducing asset buys in “measured steps” if economic figures continue to improve.
After an initial decline, equity markets rebounded, suggesting investors view the Fed’s action as confirmation of improving economic fundamentals.
KEY POINTS: * The Fed sought to temper the long-awaited move by suggesting its key interest rate would stay lower for even longer than previously promised. * The Fed trimmed equally from mortgage and Treasury bonds, reducing to $35 billion in mortgage securities and $40 billion in Treasury bonds. * The Fed’s asset purchase program, a centerpiece of its crisis-era policy, has left it holding roughly $4 trillion of bonds, and the path it must follow in dialing it down is rife with numerous risks, including the possibility of higher-than-targeted interest rates and a loss of investor confidence.
COMMENTS: DAVID JOY, CHIEF MARKET STRATEGIST, AMERIPRISE FINANCIAL, BOSTON:
“I am surprised the Fed chose to move today. Certainly they can justify the decision. However, I expected them to wait another meeting or two to ensure that the recently strong economic data was sustained.
“Nevertheless, tapering was going to happen eventually. In the larger scheme of things, this is a vote of confidence in the economy and represents the first step toward monetary policy normalization. The forward guidance on rates was dovish, as the Fed endeavors to minimize any negative fallout from the decision to taper. The bond market appears to be taking the decision in stride, suggesting that this move had been well discounted, while stocks have risen in an apparent reaction to the better economic outlook that the Fed has just endorsed. The dollar is firming as might be expected.
“However, initial reactions can often times be deceiving, so how markets close today, and react in the days ahead, will be important.”
ERIC GREEN, GLOBAL HEAD OF RATES AND CURRENCY RESEARCH AND STRATEGY, TD SECURITIES, NEW YORK:
“It was a bit surprising in that they chose December over January…everything was in place for them to taper, they had all the evidence they needed to taper at this point in time, but we thought they would probably choose to do it in January.
“It is a small taper, but it means they can proceed in January with another $5 billion to $10 billion if they choose, which means you are at a $20 billion mark where we thought we would have been at the end of January, but we are just starting a little earlier. This is a good move for policy in that QE is looking increasingly like an anachronism in the current environment, and if it’s anachronistic and they don’t like it then it’s well past the time that they should move away from it.”
ERIC STEIN, CO-DIRECTOR, GLOBAL INCOME GROUP, EATON VANCE INVESTMENT MANAGERS, BOSTON:
“The Fed didn’t change the unemployment threshold, but they made the forward guidance somewhat more dovish, saying rates will be near zero well past 6.5 percent. Also, the expected fed funds rate as of December 2016 is now 1.75 percent versus 2 percent. So that language is somewhat more dovish than before. U.S. Treasury yields rose when the statement first came out, but are now lower than they were before the announcement.”
RICK MECKLER, PRESIDENT OF HEDGE FUND LIBERTYVIEW CAPITAL MANAGEMENT LLC IN JERSEY CITY, NEW JERSEY:
“They finally pulled a Band-aid off that they’ve been tugging at for a long time. The initial reaction is that tightening will be bad for stocks, but upon further reflection investors realize that to some extent tightening represents a view that the economy is stronger and can survive higher rates.
“This is a market that for a long time has wondered if good news is bad news or bad news is good news. If the Fed feels we’ve gotten to a point where they can begin to withdraw some of the stimulus there’s at least some positive thought that we’re in better economic shape and therefore stocks can do better.”
AXEL MERK, PRESIDENT AND CIO, MERK INVESTMENTS, PALO ALTO, CALIFORNIA:
“You can call this tapering, but they still haven’t given us a real end point. They’re just caving into market pressure to do something. But real tapering would have involved giving an end point for when they will stop increasing the balance sheet. They’re still giving the impression that they’ll be late raising rates, so I’m not sure how hawkish this really is.”
MICHAEL WOOLFOLK, SENIOR CURRENCY STRATEGIST, BNY MELLON, NEW YORK:
“This was a surprise to me and I think to the market. We’ve had some understandable volatility in the currency market. Bond yields rose but it doesn’t appear we’ll hit 3 percent in the 10 year today. It seems clear that (Fed Chairman Ben) Bernanke, on his way out, wanted to set the machinery in motion and break down any resistance to getting started.
“It’s certainly supportive for the dollar, though we are a little concerned about how the stock market is going to take this. As for the Fed, the September disappointment and the December surprise have really called into question the efficacy of the Fed’s transparency.”
WAYNE KAUFMAN, CHIEF MARKET ANALYST AT ROCKWELL SECURITIES IN NEW YORK:
“Cutting the amount by $10 billion is a good signal that QE won’t be a forever thing. I think people were prepared for this, and I think they are relieved that the Fed is starting. No one wanted this 800-pound gorilla in the market; I wanted them to start tapering in September. I’m not surprised to see markets rebound, since we’ve already seen a lot of weakness recently. Before today, we only had two positive sessions this month.”
MARKET REACTION:
STOCKS: U.S. stock indexes initially fell before rebounding, and turning substantially higher BONDS: U.S. bond prices initially added to losses, then reversed to nearly unchanged FOREX: The dollar rose against the euro before reversing, with the euro now higher
(Americas Economics and Markets Desk; +1-646 223-6300)