Wednesday, October 29, 2014

Fed ends QE3 and sends upbeat signals on economy

The Federal Reserve voted on Wednesday to end its bond-buying stimulus program commonly known as QE3 and sent several upbeat signals to markets that it was not worried about global weakness, low inflation or a wobble in financial markets. 

In the statement, the Fed left unchanged its pledge that rates would remain near zero for a "considerable time." 

But it qualified the statement, saying that if the economy improves faster than expected, than the first rate hike could come sooner than anticipated. 

The statement also made a major change to the Fed's view on labor markets. Instead of seeing "significant underutilization" in the labor market, which was in the September statement, the Fed now said that underutilization in labor resources "is gradually diminishing." 

On inflation, the U.S. central bank dismissed concern with the drop in inflation expectations seen in financial markets. It said that surveys of longer-term inflation expectations have "remained stable." It said that low inflation has been held down by low energy prices and "the likelihood of inflation running persistently below 2% has diminished somewhat since early this year." 

U.S. stocks (SPX) sagged immediately after the statement. 

As a result of these changes only one member of the ten-member Open Market Committee dissented -- Narayana Kocherlakota, the president of the Minneapolis Fed and the most ardent dove on the committee. 

Two hawks who had dissented in September -- Richard Fisher of the Dallas Fed and Charles Plosser, the president of the Philadelphia Fed --support the Fed policy statement. 

The U.S. economy has been performing well this year after a weak first quarter. Economists are forecasting the best nine-month stretch of growth since 2005-2006, with growth expected over 3%. 

But weakness in Europe, recent strength of the dollar (DXY) , and also consistently low readings of U.S. inflation has raised concern that the U.S. economy might not be able to sustain growth above a 3% rate for very long. 

The Fed has been steadily tapering its bond buying program this year down from $85 billion per month as the labor market has shown impressive improvement. The central bank was only purchasing $15 billion in assets in October. 

The Fed has purchased $1.6 trillion in bonds in this latest round of asset purchases. Its balance sheet is now close to $4.5 trillion, up from around $800 billion prior to the financial crisis. 

Severe market volatility raised the possibility that the Fed might delay its planned ending of QE3 until December but the central bank decided to move ahead. 

With the Fed bond buying ended, markets will now focus on when the Fed will raise interest rates. 

There are sharp divisions among Fed officials on the timing of the first rate hike. 

Before the statement was released, the market was expecting the first rate hike in October 2015, a few months later than the "mid-2015" guidance from key allies of Fed Chairwoman Janet Yellen. 

Yellen has repeatedly stressed that the decision to hike rates will be data driven. 

By; Greg Robb