Ignoring market turmoil, Fed continues to withdraw stimulus

A steep drop in U.S. job growth last month and recent tremors in financial markets around the world isn't stopping the Federal Reserve from winding down its economic stimulus program.

The Federal Open Market Committee, which sets interest rates, said Wednesday that it will trim its monthly purchases of mortgage and Treasury securities by $10 billion, from $75 billion to $65 billion. That reduction matches the Fed's cut in January. The central bank also reiterated its plan to keep short-term rates at record lows.

FOMC members voted unanimously to continue "tapering" the bond buys, underlining a consensus among policymakers that the economy is healthy enough to stand on its own. The panel, which sets interest rates for the Fed, said that economic activity has "picked up" in recent months.

"Labor market indicators were mixed but on balance showed further improvement," it said in a statement. "The unemployment rate declined but remains elevated. Household spending and business fixed investment advanced more quickly in recent months, while the recovery in the housing sector slowed somewhat."

The Fed started tapering its bond purchases this month, from $85 billion a month to $75 billion. In announcing plans to begin unwinding the program in December, the FOMC said the U.S. economy was expanding at a "moderate" pace.

The Fed began the bond purchases, a policy known as "quantitative easing, in 2009 in order to keep a lid on interest rates and spur economic activity.

Exceptionally weak job-creation last month had spurred speculation that the Fed might pause in reducing the bond purchases to see if the labor market recovered. After adding a healthy 241,000 jobs in November and average payroll gains of 205,000 over the preceding three months, employers added only 74,000 jobs in December.

Most economists attributed the plunge to the deep freeze that affected much of the U.S. last month, and they predict that job growth will rebound. Meanwhile, broad financial conditions have remained fairly stable despite a sell-off in stocks in recent days that followed turmoil in emerging markets.

The latest data on manufacturing, industrial production and retail sales, along with the Fed's own regional surveys, suggest strengthening economic growth, according to Goldman Sachs (GS) analysts. 

The Fed's move to wean the economy off its support has rattled investors. Countries such as Argentina, Turkey and other emerging markets have seen stocks plummet as investors withdrew capital in expectation of higher bond yields in the U.S.

Despite these wobbles, "The problems in emerging markets didn't even warrant a mention in the statement accompanying the FOMC's decision," noted Paul Ashworth, chief U.S. economist with Capital Economics, in a report. "Indeed, the surprise is that statement was notably more upbeat on the economic outlook."

An important gauge of how the economy is faring will come Thursday, when the U.S. Commerce Department releases its initial GDP estimate for the final three months of the year. The economy grew  4.1 percent in the third quarter, although that robust growth was inflated by businesses adding to their inventories, which is likely unsustainable. 

Economists now expect the economy to have expanded roughly 3 percent to 3.5 percent in the fourth quarter, with some experts predicting even stronger growth.

The FOMC meeting was the last presided over by Fed Chairman Ben Bernanke, who is leaving the central bank at the end of the month.

Incoming Fed chief Janet Yellen will take the helm in February. Yellen, who like Bernanke has been a proponent of using monetary policy to stimulate economic growth, is expected to continue easing bond purchases.

The Fed has said the program is likely to be discontinued by year-end, although that is contingent on how the economy -- especially the job market -- performs. The Fed has said it intends to keep monetary conditions loose well after the unemployment rate, now at 6.7 percent, falls to 6.5 percent.

Ian Shepherdson, chief economist with Pantheon Macroeconomics, said in a note to clients that the FOMC's economic forecast "is a bit more upbeat than in December, suggesting the Fed is (even) more comfortable with its decision to taper."