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The U.S. Federal Reserve on Wednesday surprised the markets by delaying the long-debated tapering of its current monthly 85-billion-dollar bond buying program, citing concerns over tighter financial conditions and fiscal headwinds, leaving the actual wind-down of the monetary stimulus down the road.
Keep QE in place
The Federal Open Market Committee, the policy setting arm of the U.S. Federal Reserve, said in a statement on conclusion of its two-day policy meeting that they noticed economic gains despite fiscal drag, but decided to await more evidence that the economic progress will be sustained before adjusting the pace of quantitative easing, or QE.
The Fed is currently buying 45 billion dollars per month of Treasury debts and 40 billion dollars per month of mortgage-backed securities. Many investors expected the central bank to begin scaling back the bond purchases by a modest 10 billion to 15 billion dollars in its September meeting.
"Mortgage rates have risen further and fiscal policy is restraining economic growth," the Fed said, warning that "the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market."
"Economic data have been weak and long-term interest rates have risen a lot since June, which will further weaken the housing recovery. This calls for continued asset purchases," said Joseph Gagnon, senior fellow at Peterson Institute for International Economics.
At a press conference following the statement, Bernanke said in addition to a sharp rise in the long-term interest rates, federal fiscal policy continues to be an important restraint on growth and a source of downside risk.
"A government shutdown, and perhaps even more so, a failure to raise the debt limit, could have very serious consequences for the financial markets and for the economy," Bernanke warned, as a showdown looms between the Congressional Republicans and the White House over federal spending and debt limit.
To reinforce its message to the market, the Fed reaffirmed its pledge not to raise the federal funds rate as long as unemployment rate is 6.5 percent or higher and the outlook for inflation doesn' t exceed 2.5 percent.
No fixed schedule for stimulus taper
Postponing the retreat from QE signaled that the Fed was still concerned over the economic prospects and worried that premature reduction would derail the recovery.
"Economic growth has generally been proceeding at a moderate pace with continued, albeit somewhat uneven, improvement in labor market conditions," said Bernanke. "To say that the job market has improved does not imply that current conditions are satisfactory."
Questioned by whether the delay in tapering would send confusing signals to the market, Bernanke replied "what we are going to do is the right thing for the economy."
"We can't let market expectation dictate our policy actions," said Bernanke, stressing that the Fed officials would continue to try their best to communicate their policy intentions.
"The markets were understandably surprised by today's decision by the Fed not to begin tapering its asset purchases. Long-term interest rates fell in the United States and the stock market rallied," said David Stockton, a former Fed chief economist. "But the Fed's talk of tapering earlier this year served (as) a wake up call to markets, especially those involving emerging markets, that simply cannot be taken back."
Bernanke struck a less confident tone on the timeline he outlined in June that the Fed would take the first step in scaling back asset purchases later this year and end it by the middle of next year. "There is not any magic number that we are shooting for. We are looking for overall improvement in the labor market," he said.
Noting there is "no fixed calendar" for the tapering, Bernanke said if the incoming data confirm the basic outlook, the Fed would take a first step "at some point, possibly later this year."
In an updated economic forecast, the Fed lowered the growth for 2013 between a range of 2 percent to 2.3 percent, down from 2.3 percent to 2.6 percent in its June estimates. The downgrade for next year was even sharper as growth for 2014 is projected to stand at 2.9 percent to 3.1 percent, down from the previous outlook of 3 percent to 3.5 percent.
Twelve out of 17 policy makers estimated that the first rise in federal funds rate from its current near-zero level would not come until 2015. They also expected the unemployment rate, which was 7. 3 percent as of August, to fall between 7.1 percent to 7.3 percent by the end of this year.
