WASHINGTON – The Federal Reserve has sent its strongest signal of confidence in the U.S. economy since the recession struck six years ago: It’s decided the economy is finally strong enough to withstand a slight pullback in the Fed’s stimulus.
Yet the Fed also made clear it’s hardly withdrawing its support for an economy that remains below full health. Chairman Ben Bernanke stressed that the Fed would still work to keep borrowing rates low to try to spur spending and growth and increase very low inflation.
At his final news conference as chairman before he leaves in January, Bernanke managed a delicate balance: He announced a long-awaited and long-feared pullback in the Fed’s stimulus. Yet he did so while convincing investors that the Fed would continue to bolster the economy indefinitely. Wall Street roared its approval.
The Fed said in a statement after its policy meeting ended Wednesday that it will trim its $85 billion a month in bond purchases by $10 billion starting in January. Bernanke said the Fed expects to make “similar moderate” cuts in its purchases if economic gains continue.
At the same time, the Fed strengthened its commitment to record-low short-term rates. It said for the first time that it plans to hold its key short-term rate near zero “well past” the time when unemployment falls below 6.5 percent. Unemployment is now 7 percent.
The pullback will be the first step toward winding down a crucial stimulus program that has been in place, in one form or another, since the financial crisis.
By purchasing bonds and depressing their yields, the Fed has encouraged borrowing and lending, but also led investors to shift money into stocks.
That has given the Fed a big role in the current bull market. The S&P 500 index has surged about 26 percent since the Fed announced a year ago that it would buy the $85 billion in bonds each month. And since the central bank’s first round of bond buying at the end of 2008, stocks have soared about 124 percent.
As a result, stock investors have anxiously awaited a pullback since spring, when Fed Chairman Ben Bernanke first hinted the Fed could start reducing the purchases.
Nevertheless, investors seemed elated by the Fed’s finding that the economy has steadily strengthened, by its firm commitment to low short-term rates, and by the only slight amount by which it’s paring back its bond purchases.
The Dow Jones industrial average soared nearly 300 points. Bond prices fluctuated, but by late afternoon the yield on the 10-year Treasury note had barely moved. It inched up to 2.89 percent from 2.88 percent.
The stock market has enjoyed a spectacular 2013, fueled in part by the Fed’s low-rate policies. Those rates have led many investors to shift money out of low-yielding bonds and into stocks, thereby driving up stock prices.
Still, the gains have been unevenly distributed: About 80 percent of stock market wealth is held by the richest 10 percent of Americans.
Critics have argued that by keeping rates so low for so long, the Fed has heightened the risk of inflating bubbles in assets such as stocks or real estate that could burst with devastating effect. Bernanke has said the Fed remains watchful of such risks.
But he has argued that still-high unemployment and ultra-low inflation justify continued Fed stimulus.
Bernanke will step down from the Fed on Jan. 31 and be succeeded by Vice Chair Janet Yellen, whose nomination the Senate is expected to confirm as soon as this week.
Asked at his news conference about Yellen’s role in the decision the Fed announced, Bernanke said: “I have always consulted closely with Janet, even well before she was named by the president, and I consulted closely with her on these decisions as well, and she fully supports what we did today.”
In updated economic forecasts issued Wednesday, the Fed predicted that unemployment would fall a bit further over the next two years than it thought in September. It expects the unemployment rate to dip as low as 6.3 percent next year and 5.8 percent in 2015.
Yet the Fed expects inflation to remain below its target level. Policymakers predict that their preferred inflation index won’t reach its target of 2 percent until the end of 2015 at the earliest. For the 12 months ending in October, the inflation index is up just 0.7 percent.
The Fed worries about very low inflation because it can lead people and businesses to delay purchases. Extremely low inflation also makes it costlier to repay loans.
In its statement, the Fed said it will reduce its monthly purchases of mortgage and Treasury bonds each by $5 billion. Beginning in January, it will buy $35 billion in mortgage bonds each month and $40 billion worth of Treasurys.