At Long Last, Tapering Is Underway

Wednesday, the Fed announced that it would start tapering its asset purchases. Initially, the stock market fell on the news of the $10 billion tapering; however, it quickly reversed course and the DOW and S&P 500 both closed at all-time highs.

The tapering of the Fed’s Quantitative Easing program is a sign of economic strength, reflecting the Fed’s belief that the economic environment is continuing to improve. The Fed also hopes to cut the amount of its monthly purchases in $10 billion increments at future meetings, as long as economic data warrants it. If the Fed proceeds at the pace laid out by Ben Bernanke, it would complete the bond-buying program toward the end of 2014 with holdings of nearly $4.5 trillion in bonds, loans and other assets, nearly six times as large as the Fed’s total holdings when the financial crisis began in 2008.Last

For investors, one of the most important aspects of the Fed’s announcement was its new promises that short-term interest rates would stay low long after the bond-buying program ends, as low interest rates provide some support for stock prices. On Wednesday, the Fed said it planned to keep rates near zero “well past” the point when the Fed’s 6.5% unemployment rate target is reached. In fact, the vast majority of Fed officials anticipate that short-term rates will stay near zero until 2015 or later, even though they think the jobless rate will fall to 6.5% next year.

The economic data continues to improve – as evidenced by Friday’s upward revision of third quarter GDP growth to 4.1%, the fastest pace since 2011’s fourth quarter – and there is a budget deal in place. On the other hand, the debate over the debt limit still looms in the New Year. The progression of those talks could impact the stock market. Another challenge is inflation, which has fallen well below the central bank’s objective. Hopefully, the debt limit talks will be relatively painless and inflation will return to target levels. However, if they do not, given our more positive long-term view, any pullback could create an opportunity to acquire high-quality securities at attractive prices.