Markets jump to record highs on Fed decision to keep stimulus

September 18, 2013

The Federal Reserve said Wednesday that it will keep its multibillion-dollar stimulus program intact, surprising investors and sending stocks to record highs.

Federal Reserve Chairman Ben Bernanke (AP/Manuel Balce Ceneta)

Signaling concern that the nation’s tepid economic recovery is still not ready to stand on its own, the Fed referred to tighter financial conditions and "federal fiscal retrenchment" as shaping its decision to continue buying $85 billion a month in bonds. The central bank said it would like to see more evidence that the recovery will be sustained before scaling back its purchases.

The decision, coming at the end of the central bank's two-day policy meeting, stunned investors, many of whom had expected the Fed to begin reducing its purchases of long-term bonds. Markets spiked on the announcement, with the three major indexes rising by 1 percent, and continued to climb during Chairman Ben Bernanke's news conference. On market closing, the Standard & Poor's index and  Dow Jones Industrial Average were at record highs, with the S&P up 1.2 percent and the Dow climbing 147 points, or 1 percent.

In addition, Fed officials voted to keep short-term interest rates near zero. They have promised not to increase them at least until the jobless rate hits 6.5 percent or inflation rises above 2.5 percent. Meanwhile, the yield on the 10-year Treasury note fell 0.17 percentage points to 2.69 percent.

“These actions should maintain downward pressure on longer-term interest rates, support mortgage markets and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery,” the statement said.

The Fed also lowered its forecast for growth through next year. Officials now believe the nation’s gross domestic product will increase between 2 percent and 2.3 percent this year, down from 2.3 to 2.6 percent. GDP is expected to pick up to 2.9 to 3.1 percent next year. Their forecast for the unemployment rate remained relatively constant for the year at 7.1 percent to 7.3 percent, then falling to from 6.4 percent to 6.8 percent next year.

The central bank’s reluctance to abandon its crisis-era position underscores just how fragile the recovery remains. The last time the Fed conducted the bond purchases known as quantitative easing, it was criticized for cutting off the program before the economy had fully healed. The decision to keep pumping money into the recovery shows they are worried about making the same mistake this time.

The vote also provides some stability at a time when the Fed itself is facing significant upheaval.Bernanke is not expected to stay when his term expires in January, and a White House official said Wednesday that the central bank’s second-in-command, Janet Yellen, is the leading candidate to replace him. As many as four seats on the Fed’s policy-setting committee could turn over as well.

The Fed’s decisive actions in the months following the financial crisis — bailing out banks, slashing interest rates and pumping money into the economy  — were hailed as necessary steps to prevent the next Great Depression. But as the recovery grinds along, a growing chorus of critics, some of them inside the central bank itself, have questioned whether those policies are still necessary.

Kansas City Fed President Esther George dissented from the committee’s decision, citing concerns that the easy-money stance risks stoking future inflation and breeds financial instability.

The major indexes markets plunged in June when Bernanke announced officials would likely scale back purchases by the end of the year. A sell-off in the bond market sent long-term interest rates soaring, with 30-year fixed-rate mortgages up a percentage point since April. Banks reported that the increase choked off refinancing activity and dampened appetite for home purchases.

The Fed’s policy-setting committee is slated to meet twice more this year.

Read The Washington Post's live coverage of the Fed decision and the press conference by Chairman Ben Bernanke here.

Ylan Q. Mui is a financial reporter at The Washington Post covering the Federal Reserve and the economy.
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