Fed chief's exit may spell the end for US economic stimulus

Ben Bernanke

This week Ben Bernanke chairs his last meeting as head of the Federal Reserve – a position that has undoubtedly become the most important job in finance under his tenure.

When that meeting ends on Wednesday, investors and government officials around the world will be waiting to see if Bernanke's exit will also signal the unwinding of his signature policy.

In November 2008, as the world was rocked by the worst financial crisis in living memory, Bernanke launched a series of ambitious, costly and controversial attempts to put the US economy back on course. The wonkish-sounding "quantitative easing" (QE) programme aimed to bring down interest rates and encourage investment, by buying billions in bonds and other securities.

The third round of QE was launched in September 2012 and under it the Fed is currently buying $85bn a month in mortgage-backed securities and other bonds. So far QE3 has added $1.1 trillion to the Fed's balance sheet and critics have worried about unintended consequences like a housing bubble or artificially inflated stock markets.

But the medicine appears to be working. Unemployment has come down to a five-year low, house prices are slowly rising, inflation seems under control and stock markets are near record highs. Bernanke has signalled he will begin cutting QE when the economy is stronger. So will December be the month that US Inc is ready to go it alone?

"The economy is undoubtedly stronger than it was in September 2012," said Gus Faucher, senior macroeconomist at PNC Bank. "I still think January is more likely. I think they'll want more data."

Paul Ashworth, chief US economist at Capital Economics, said December could be the month, but that doubts remained. "I'd put it at 60/40," he said. "The problem is Fed officials are very vague. Every official seems to have a different way of looking at the data."

Perhaps the simplest way to look at whether the Fed is ready to "taper" QE now is to look at the reasons it set out for not cutting back in September, the last time that it held a major meeting and press conference. Then Fed officials had three main concerns: Washington's seemingly endless budget battle, a stutter in the jobs market's recovery and a rise in long-term interest rates. A lot has changed in the last three months.

Last week Congress finally agreed a budget, ending more than two years of economically destabilising battles. Questions remain, but the willingness to reach a deal – long absent in Washington – is a good start.

Bernanke has consistently cited political infighting as a drag on the economy. Last September's meeting came before a government shutdown many feared would damage the still-struggling economy. The new deal, while modest in scope, amounts to a ceasefire that will come as a huge relief to business leaders looking for real answers from Washington on issues such as immigration and the tax code.

The jobs market also seems to be on the mend. The unemployment rate fell to a five-year low of 7% last month. The US had added 203,000 new jobs in November, the 38th consecutive month of growth, but, more importantly for the Fed, jobs growth has now averaged more than 200,000 a month over the last four months.

Again though, problems remain. The drop in unemployment is partly driven by people giving up and leaving the workforce. Long-term unemployment remains high, as does youth unemployment. The jobless rate for African-Americans is 12.5%, more than twice the 6.2% rate for white people and higher than the level for Hispanics, 8.7%. There is some way to go before the US makes up for the jobs it lost in the recession. Some have speculated that it may never get there. But the fact remains that the job market is stronger now than it was in September.

The final concern the Fed expressed back in September was about interest rates. Long-term interest rates started rising in May after the Fed hinted it might start cutting back on QE. Since then the Fed has been at pains to emphasise that any tapering in QE will not be paired with a rise in its base rates. The message seems to have got through and long-term rates have dipped.

Mark Zandi of Moody's Analytics said it looked certain that QE would be cut soon, but thought it more likely to happen under the tenure of Bernanke's successor, Janet Yellen. The programme had largely worked: the difficulty the Fed now faced was how to unwind it, he said.

"The biggest risk now is, can they bring this to an end gracefully?" he said. "Janet Yellen is going to own that. She should start it."

Powered by Guardian.co.ukThis article was written by Dominic Rushe in New York, for The Observer on Sunday 15th December 2013 00.05 Europe/London

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image: © Shirley Li/Medill DC

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