The Federal Reserve said Wednesday it will begin to wind down its trillion-dollar stimulus program at the start of next year, a sign of its growing conviction that the American economy is strengthening.
The vote of confidence sent stock markets soaring to record highs as investors celebrated the rosier outlook. The Fed pointed to steady hiring by businesses and resilient consumer spending as signs that the recovery has taken hold. On Capitol Hill, lawmakers approved a budget deal that ends the political brinkmanship that has loomed over the recovery for the past three years.
The combination of an improving private sector and less disruption from Washington cleared the way for the Fed to begin unraveling its extraordinary efforts to safeguard the economy.
“This is an endorsement by the Fed of improving economic prospects,” said Eric Lascelles, chief economist at RBC Global Asset Management. “Ultimately, that’s gotta be a good thing.”
For about a year, the nation’s central bank has pumped money into the economy by buying mortgage-backed securities and Treasury bonds. The goal was to push down long-term interest rates and boost demand among consumers and businesses. Mortgage rates hit historic lows, helping to revive the moribund housing sector, and auto sales surged.
Next month, the Fed will scale back its support from $85 billion a month to $75 billion — cutting $5 billion each from mortgage and Treasury bond purchases. Fed Chairman Ben S. Bernanke said the program will probably continue to shrink in “similar, moderate steps” at future meetings and end altogether late next year.
But he cautioned that the pace is not predetermined; instead, it will depend on the progress of the recovery. Officials could skip “a meeting or two” if they are disappointed in the economic data, he said.
“Asset purchases remain a useful tool that we will deploy as needed to meet our objectives,” Bernanke said during a news conference Wednesday.
Officials also stressed that the decision does not affect the central bank’s commitment to keeping short-term interest rates near zero. The Fed on Wednesday said rates will probably remain low well after the unemployment rate reaches 6.5 percent — stronger language than it has used in the past. The central bank also said it is unlikely to raise rates while inflation is below its target of 2 percent.
Documents released Wednesday showed the majority of the Fed’s top officials do not expect rates to increase until 2015. Three even predicted the first hike will not occur until 2016.
Still, the decision to scale back the stimulus — even by a little — marks an important milestone in the country’s long road back from the recession. The Fed has been criticized for ending earlier rounds of stimulus too early, and officials were determined not to make the same mistake again.
But picking the right time to pull back has been difficult. The Fed tied the program to the health of the labor market yet remained vague about what that meant. The picture was further clouded by confusing economic data, including a drop in the unemployment rate that was driven more by a shrinking workforce than a pickup in hiring. Meanwhile, a vocal minority of Fed officials raised concerns that the unconventional program could have unintended consequences, such as creating bubbles that breed financial instability.
The Fed’s initial attempts to prepare the markets and the public for the program’s inevitable end seemed to backfire. Stock markets plunged after Bernanke suggested this summer that the Fed would pull back by the end of the year. Interest rates also shot up, threatening the still-fragile housing market.
But Wall Street seemed to get the message this time.
On Wednesday, the blue-chip Dow Jones industrial average rose nearly 300 points to reach a new record high of 16,167.97. The Standard & Poor’s 500-stock index jumped 30 points, up 1.7 percent, also setting a new high at 1810.65.
“The market was well-positioned for tapering” of the stimulus, said Eric Green, global head of rates, foreign exchange and commodity research at TD Securities. “The Fed gave investors a boost of confidence today.”
Although the tone of the Fed’s statements was more positive, the central bank’s outlook for economic growth next year has changed little since September. It forecasts the nation’s gross domestic product will grow between 2.8 and 3.2 percent next year, in line with previous forecasts. But the unemployment rate is expected to drop more quickly, with predictions ranging between 6.3 and 6.6 percent for 2014. The Fed slightly lowered its outlook for inflation, as well.
The central bank’s announcement came after top officials concluded their regular two-day meeting in Washington. The Fed’s influential policy-setting committee voted 9 to 1 to scale back the stimulus. Boston Fed President Eric S. Rosengren dissented because he believed the reduction in bond purchases was “premature.”
Bernanke will preside over one more meeting as chairman before his term ends Jan. 31. The Senate will probably confirm the central bank’s second-in-command, Janet Yellen, as his successor this week.
Bernanke suggested Wednesday that there was strong support among his colleagues for the strategy he outlined for ending the bond-buying program. He and Yellen have been close allies on policy decisions, and she is not expected to change course dramatically.
“I have always consulted closely with Janet,” Bernanke said Wednesday. “She fully supports what we did today.”