The Federal Open Market Committee announced today another step toward scaling back its quantitative easing program, despite recent warning signs from the economy.
The Fed's revised course of action
The Fed announced another $10 billion reduction in its monthly asset purchases, duplicating the reduction that it announced after its December meeting. Its monthly long-term bond purchases, designed to keep downward pressure on long-term rates, such as those on mortgages, will now be reduced to $65 billion a month, down from their peak of $85 billion a month.
The Fed noted that it is confident in taking these actions because the economy seems to have been on a course toward improvement over the past several quarters. Recent signals, however, put the steadiness of that course in question.
The economic context
Looking at the big picture, the Fed's confidence seems understandable. Real GDP growth improved in each of the first three quarters of 2013, and the unemployment rate fell from 7.9 percent to 6.7 percent last year. However, recent evidence suggests that the economic recovery might be losing some steam:
- Employment weakened. After running at a pace of around 200,000 for a few months, job creation slipped to just 74,000 in December.
- New home sales slipped. New home sales dipped by 7 percent (including the seasonal adjustment) in December, the second consecutive monthly decline for this indicator.
- The stock market got spooked. By late January, the stock market had lost nearly 4 percent during the month. While the Fed cannot be held hostage by the stock market in making its monetary policy decisions, the market's weakness leading up to the recent meeting introduces another element of risk in further cutting quantitative easing at this time.
The next 10 days will bring further illumination on whether the Fed's continuing confidence in the economy is justified. The first official estimate of fourth-quarter GDP growth will be announced January 30, and February 7 will bring the employment report for January.
Impact on bank rates
The impact of the Fed's decision on bank rates is likely to be split, depending on what type of bank rates you are looking at. The Fed's long-term asset purchases were designed to bring rates such as mortgage rates down, so tapering back the program could allow mortgage rates to rise further than the 1 percent or so they gained last year. However, this also depends on whether the economic recovery appears to be continuing or faltering.
As for those beleaguered CD rates, savings account rates and money market rates, the Fed's continued commitment to keep short-term rates near zero leaves little chance that they will rise. As with mortgages, the fate of these bank products ultimately depends on whether the economy can shake off its apparent winter blues.