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Fed pulls trigger on tapering, will trim bond buying by $10B a month

Fed pulls trigger on tapering, will trim bond buying by $10B a month

Stocks popped on news that the Federal Reserve will begin to shrink their monthly bond purchases by $10 billion, citing moderate economic expansion. Stocks responded well to the news with the Dow Jones Industrial Average (DJI) closing up 293 points for a new record closing high of 16,167. The S&P 500 (GSPC) followed suit closing up nearly 30 points on the news out of Washington.

In a statement released by the Fed earlier today, the panel wrote, “In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the Committee decided to modestly reduce the pace of its asset purchases.” In other words, some key indicators have recently shown that the economy has recovered enough to begin backing off of the tactics used to prop it up over the past five years.

To be sure, the era of unprecedented market intervention by the Fed known as quantitative easing, or Q-E, has been filled with controversy since it was first deployed in the throes of the financial crisis in 2008, then renewed in 2010 and rejiggered again in September 2012. While time and historians will gauge whether or not the program will be deemed a success, there’s no question that it was a boon for stocks, which outperformed all other asset classes during that period of time and more than doubled.

As Greg McBride, senior financial analyst at Bankrate.com, and I discuss in the attached video, regardless of what the market and economists were expecting, a huge, long-standing variable has been removed from the markets.

"There's no sense delaying the inevitable," McBride says, adding that  "you can't go much smaller than tapering off $5 billion on each the Treasury and the mortgage backed securities."

While stocks appeared to like the move in the short-term, McBride says tomorrow could bring a totally different reaction.

“How many times have we seen this where, after the Fed meeting, the market does one thing and then once everyone sleeps on it and wakes up the next day, the market does the exact opposite.”

As is often the case, today’s move does not come without caveats, most noticeably the uptick in the importance of monitoring inflation over unemployment.

“The Committee now anticipates…that it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6-1/2 percent, especially if projected inflation continues to run below the Committee's two percent longer-run goal,” the FOMC statement said.

The moves come despite long-standing assertions that no such action would be taken until two economic targets were met; unemployment at 6.5% and inflation above 2%. However, a string of stronger than expected economic data lately has made it increasingly difficult for the central bank to justify the need for continued intervention, as GDP has reached 3.6% in the third quarter, 203,000 jobs were created in November, and most recently, housing starts hit a five year high.

As far as the future is concerned, the focus of attention will now shift to incoming chairman Janet Yellen, who could be confirmed by the full Senate as early as this week and would take the reins February 1st.  Officially, Ben Bernanke’s final meeting will be January 28-29th, after which the bearded, battle-tested, two-term, central bank chief will once again be a private citizen.