On December 18, the Federal Reserve announced that its bond purchasing campaign, widely known as "quantitative easing," will begin to lessen as the U.S. economy has shown signs of improvement. The Federal Reserve first mentioned its intentions of reducing bond purchases back in the spring of 2013. Following that initial announcement, markets reacted swiftly and negatively, bringing fixed income yields up and equity prices down. Since then, the United States has steadily shown encouraging signs of improving economic activity. The latest Federal Reserve move is a gradual change, and an explicit acknowledgement that the U.S. economy is heading in the right direction and financial markets are well-prepared for a reduction in monetary stimulus.
As a response to the economic downturn in 2008 and 2009, the Federal Reserve began purchasing U.S. Treasury and mortgage-backed securities in an unprecedented effort to create liquidity, keep interest rates low, and ultimately support the economic system. The policy was designed to be accommodative, purchasing $85 billion in fixed income securities per month, in order to revive economic growth, lower unemployment, and induce a healthy, moderate amount of inflation. Since the policy began, the Federal Reserve's balance sheet has expanded from well below the $1.0 trillion mark to nearly $4.0 trillion today. Beginning in January 2014, bond purchases by the Federal Reserve will be scaled back modestly from $85 billion a month to $75 billion. A continued reduction of future bond purchases will be dependent upon a lower unemployment rate and encouraging signs of economic expansion.
Reaction to the Federal Reserve announcement was positive, as measured by the S&P 500, which rose nearly 1.7% on the day of the news. The domestic bond market, as measured by the Barclays Aggregate, was modestly negative by 14 basis points. The reduction in Federal Reserve bond purchases could be interpreted as a vote of confidence in the U.S. economy and financial markets. Ultimately, the Federal Reserve may be initiating this exit from the financial markets as a necessary and appropriate conclusion to its unprecedented efforts to stimulate the economy. With that said, the Federal Reserve was explicit about its intention to maintain low levels of interest rates until it is comfortable with a healthy level of inflation and unemployment is at or below 6.5%.
As a response to the economic downturn in 2008 and 2009, the Federal Reserve began purchasing U.S. Treasury and mortgage-backed securities in an unprecedented effort to create liquidity, keep interest rates low, and ultimately support the economic system. The policy was designed to be accommodative, purchasing $85 billion in fixed income securities per month, in order to revive economic growth, lower unemployment, and induce a healthy, moderate amount of inflation. Since the policy began, the Federal Reserve's balance sheet has expanded from well below the $1.0 trillion mark to nearly $4.0 trillion today. Beginning in January 2014, bond purchases by the Federal Reserve will be scaled back modestly from $85 billion a month to $75 billion. A continued reduction of future bond purchases will be dependent upon a lower unemployment rate and encouraging signs of economic expansion.
Reaction to the Federal Reserve announcement was positive, as measured by the S&P 500, which rose nearly 1.7% on the day of the news. The domestic bond market, as measured by the Barclays Aggregate, was modestly negative by 14 basis points. The reduction in Federal Reserve bond purchases could be interpreted as a vote of confidence in the U.S. economy and financial markets. Ultimately, the Federal Reserve may be initiating this exit from the financial markets as a necessary and appropriate conclusion to its unprecedented efforts to stimulate the economy. With that said, the Federal Reserve was explicit about its intention to maintain low levels of interest rates until it is comfortable with a healthy level of inflation and unemployment is at or below 6.5%.