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The Federal Reserve Building in Washington. (STELIOS VARIAS/Reuters)
The Federal Reserve Building in Washington. (STELIOS VARIAS/Reuters)

U.S. economy

Fed officials support stimulus taper this fall Add to ...

U.S. stocks and bonds were jolted after the Federal Reserve released the minutes from its past policy meeting in July, providing more evidence that the central bank is intent on winding down a key part of its economic stimulus as early as next month.

The Fed offered no official timeline for when the tapering might begin, but the minutes indicated that officials are “broadly comfortable” with chairman Ben Bernanke’s plan to reduce its bond-buying program, known as quantitative easing or QE, later this year and end it by mid-2014.

“While it’s far from a certainty, the minutes from the [Fed] meeting back in late July appear to support our view that the Fed will begin to slow its monthly asset purchases at the next meeting in mid-September,” said Paul Ashworth, chief U.S. economist at Capital Economics.

He believes the first step would reduce bond purchases by $10-billion (U.S.) a month, which is smaller than he had initially expected.

Economists at National Bank Financial also believe that a tapering announcement could be made in September.

“Having already set up the market for a tapering this fall, it would take a true worsening of economic data (e.g. weak non-farm payrolls) to get the Fed to postpone its tapering plan to next year,” said Paul-André Pinsonnault and Krishen Rangasamy.

Each month, the Fed has been purchasing $85-billion worth of Treasury bonds and mortgage-backed securities in an effort to juice economic activity. However, it has been preparing markets for a reduction in bond-buying, a prospect that has been hanging over stimulus-driven stocks and bonds for the past few months.

The Dow Jones industrial average fell to a low of 14,880, down more than 120 points, soon after the minutes were released on Wednesday afternoon. It briefly rebounded into positive territory before sinking again into the close.

It ended the day at 14,897.55, down 105.44 points or 0.7 per cent, marking its sixth straight decline and its longest losing streak in 13 months. The broader S&P 500 closed at 1642.80, down 9.55 points or 0.6 per cent.

Stocks aren’t the only assets looking jittery over the prospect of a shift in Fed policy. Bonds, too, have turned turbulent, sending yields sharply higher and threatening to derail the economic recovery with rising borrowing costs.

The yield on the 10-year U.S. Treasury bond rose to 2.89 per cent on Wednesday, up from just 1.63 per cent in May, touching its highest level in more than two years. Yields rise as bond prices fall.

Even though economists see September as a likely starting point for the first reduction in bond purchases, recent employment numbers are feeding some uncertainty about the ultimate timing.

In the minutes, the Fed said that the unemployment rate has fallen considerably with QE and monthly payroll gains have been solid – although the payrolls report for July, released after the period covered by the minutes, was disappointing.

However, the Fed also noted that other aspects of the labour market, including the participation rate and the number of discouraged workers, have shown only modest improvements.

“While a range of views were expressed regarding the cumulative improvement in the labor market since last fall, almost all Committee members agreed that a change in the purchase program was not yet appropriate,” the minutes said.

The Fed is also sounding slightly less optimistic about the health of the broader economy. Some officials pointed to a potential drag from rising borrowing costs, higher oil prices and fiscal pressures from reduced government spending.

Nonetheless, markets have been contemplating an end to stimulus for some time, and the minutes did not alter this view.

“Overall, the minutes clearly suggest there are [Fed]members seeing the need for the pace of asset purchases to start to be slowed,” said Paul Ferley, assistant chief economist at Royal Bank of Canada. “Thus the prospect of tapering to commence some time this fall remains a very strong possibility.”

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