Financial markets tripped over themselves on Wednesday after the U.S. Federal Reserve concluded a two-day policy meeting. The Federal Open Market Committee announced that it would begin to taper asset purchases beginning in January, reducing the combined flow rate of quantitative easing to $75 billion per month from $85 billion per month.
The FOMC instructed the Open Market Trading Desk at the New York Fed to reduce its purchases of longer-term Treasury securities from $45 billion to $40 billion and its purchases of agency mortgage-backed securities from $40 billion to $35 billion per month.
The decision to taper was made “In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions.” Labor market conditions have improved fairly steadily over the past several years, but at a headline rate of 7 percent in November, unemployment, particularly long-term, “remains elevated.” This compares against a full employment target of between 5.2 and 5.8 percent headline unemployment.
This improvement in the labor market has also been somewhat undermined by a steep decline in the labor force participation rate, which was 63 percent in November, about 3 percentage points lower than its pre-crisis level. Between this, the opacity of the recovery, and surprisingly low inflation, the Fed announced that “it likely will be appropriate” to keep the target federal funds rate at the zero bound (between zero and 0.25 percent) “well past” the the time that headline unemployment declines below the 6.5 percent target previously established as part of forward guidance.
The central bank indicated that it will continue to look at alternative measures of labor market health. One such measure is the employment-to-population ratio, which was 58.6 percent in November, well below pre-crisis levels of about 63 percent.
The Fed is projecting headline unemployment to fall to a range between 6.3 and 6.6 percent in 2014, and to a range between 5.8 and 6.1 percent in 2015, with full employment reached sometime after 2016.
This zero-interest rate policy is expected to remain appropriate “especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal.” The headline price index for personal consumption expenditures, one of the Fed’s preferred measures of inflation, actually declined fractionally in October (core prices increased fractionally) and is up just 0.7 percent on the year (the core index is up 1.1 percent on the year).
The Fed projects both headline and core PCE inflation in 2014 of between 1.4 and 1.6 percent, with the lower bound edging up to 1.7 percent and 1.8 percent, respectively, by 2016. Inflation as measured by the consumer price index has also been soft, trending below the Fed’s target.
The inflation pipeline also appears devoid of pressure. The seasonally adjusted producer price index for finished goods declined 0.1 percent in November, its third consecutive sequential contraction. The headline finished goods index is now up just 0.7 percent on the year. Falling energy prices have been the primary downward pressure on overall prices, contracting 0.4 percent in November. Food prices at the producer level were flat on the month. The core PPI, which factors out food and energy prices, increased 0.1 percent on the month.
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