Fed Cites Improved Labor Market While Ending QE as Planned

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The Federal Reserve said it sees further improvement in the labor market while confirming it will end an asset-purchase program that has added $1.66 trillion to its balance sheet.

“Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate,” the Federal Open Market Committee said today in a statement in Washington. “A range of labor market indicators suggests that underutilization of labor resources is gradually diminishing,” the panel said, modifying earlier language that referred to “significant underutilization” of labor resources.

Policy makers maintained a pledge to keep interest rates low for a “considerable time.”

While saying inflation in the near term will probably be held down by lower energy prices, they repeated language from their September statement that “the likelihood of inflation running persistently below 2 percent has diminished somewhat.”

Stocks extended losses after the Fed announcement. The Standard & Poor’s 500 Index fell 0.8 percent to 1,969.29 as of 2:17 p.m. in New York. The benchmark 10-year Treasury note yielded 2.35 percent, up 5 basis points from yesterday.

Chair Janet Yellen is completing two years of bond purchases that started under her predecessor, Ben S. Bernanke, as the Fed nears its goal for full employment. She must now chart a course toward the first interest-rate increase since 2006 while confronting risks from a slowing global economy and declining inflation. The FOMC repeated it will consider a wide range of information in deciding when to raise the federal funds rate, which has been held near zero since December 2008. Most Fed officials expect to raise the rate next year, according to projections released last month.

Reinvesting Proceeds

The Fed said it will continue reinvesting proceeds from a balance sheet that swelled to a record $4.48 trillion in the course of three rounds of so-called quantitative easing that started in November 2008 during the longest and deepest recession since the 1930s.

The latest round was announced in September 2012, with monthly purchases of $85 billion in Treasuries and mortgage-backed securities. The Fed began a step-like reduction of purchases in January 2014, cutting them by $10 billion per meeting.

Minneapolis Fed President Narayana Kocherlakota dissented, saying that with low inflation expectations the Fed should commit to keeping rates low “at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset-purchase program at its current level.”

As the Fed winds down unprecedented stimulus, the European Central Bank is contemplating its own quantitative easing program to tackle the weakest inflation in five years, and Japan is continuing purchases.

Bright Spot

“The U.S. is a big bright spot in the world,” said Stephen Cecchetti, professor of international economics at Brandeis International Business School in Waltham, Massachusetts, and a former New York Fed research director. “Europe is still struggling quite a lot, Japan seems to be up and down, and China’s having some growing pains at this point.”

A cooling global economy and declining inflation are posing risks to the outlook for the U.S., which saw growth accelerate in the second quarter to the fastest pace since 2011 and unemployment drop to a six-year low last month.

A number of officials said the five-year U.S. expansion “might be slower than they expected if foreign economic growth came in weaker than anticipated,” minutes of the Sept. 16-17 FOMC meeting show. Fed Governor Daniel Tarullo said at an Oct. 11 event in Washington that he’s “worried about growth around the world.”

Market Volatility

The weakness, along with conflicts in Ukraine and the Mideast, sparked global market turbulence that sent the Standard & Poor’s 500 Index down as much 7.4 percent from its record close on Sept. 18, the day after the last Fed meeting. Ten-year Treaury notes touched the lowest since May 2013.

The S&P 500 has since rallied to recover most of its drop, resuming an advance that has seen the index almost triple since March 2009. The 10-year Treasury note yielded 2.3 percent late yesterday, below its 3.03 percent level at the end of last year.

The divergence in major economies has also helped lift the dollar against its major peers, restraining inflation and push ing back expectations for the timing of the first Fed rate in crease. The Bloomberg Dollar Spot Index, which gauges the green back against 10 major currencies, has risen close to 6 percent since July 1.

Fed funds rate futures show the probability of a rate increase by the September 2015 FOMC meeting is about 42 percent, compared with 76 percent chance at the end of last month.

Balance Sheet

Even after purchases end, the Fed’s record balance sheet will provide support to the economy by limiting the supply of government securities and suppressing long-term interest rates. The FOMC has said it expects to stop reinvestments of maturing securities only after it raises the benchmark interest rate.

When the third round of large-scale asset purchases was announced, the jobless rate was 8.1 percent, and most policy makers forecast it would fall to 6 percent to 6.8 percent by late 2015. It’s now 5.9 percent. At the same time, weakness remains in some areas of the labor market, such as long-term unemployment.

While a 17 percent drop in oil prices this year has helped drive inflation farther below the Fed’s 2 percent target, it’s also giving consumers more to spend on other goods as gasoline prices fall to the lowest level in almost four years.

U.S. chief executive officers see reasons for optimism. JPMorgan Chase & Co. CEO Jamie Dimon said last week that the world’s largest economy has “no real weak spot,” while Kenneth Jacobs, chief of investment bank Lazard Ltd., said on an earn ings call that “the U.S. economy continues to be resilient.”

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