Fed to taper in January amid improving economy

The Federal Reserve affirmed its outlook for stronger GDP growth in 2014, and said Wednesday it will reduce – or “taper” – its injection of $40 billion into the U.S. economy through securities purchases.

The December GDP forecast of 2.9% to 3.1% is marginally better than the 2.8% to 3.2% estimate given in September by the Federal Open Market Committee (FOMC).

Wells Fargo economists project a 2.5% growth, not quite as optimistic as the Fed expectation, according to a brief note published by the bank’s economic team on Wednesday (Dec. 18) following release of the FOMC meeting.

However, the FOMC announced that in January tapering will begin as the committee will reduce its holdings of mortgage-backed securities from $40 billion per month down to $35 billion. Another $5 billion will be shaved from the Treasury notes purchased each month as well.

As for the unemployment rate, the FOMC members lowered their outlook for the to 6.3% to 6.6% for 2014 in December from 6.4% to 6.8% in September. This adjustment in the unemployment rate outlook was far greater that for made for economic growth, while the top end of the inflation outlook for 2014 was actually lowered.

Wells Fargo noted this suggests the lower unemployment rate was a key factor in shifting the balance toward tapering. The Fed’s statement suggests that the “cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions” was a basis for deciding to taper.

Also factoring into the FOMC’s decision was the extent to which fiscal “restraint may be diminishing.” As expected, the inflation outlook remains below the 2% long run target throughout the 2013 to 2015 period, with the 2014 outlook adjusted to 1.4% to 1.6%, down slightly.

Wells Fargo notes that while 1.4% inflation is still well below target, this marks a significant pickup from the 0.9% rate at which members expect inflation to register in 2013.

The FOMC strengthened its commitment to keep short-term rates low, 4% stating a rise in the fed funds target would not come until the 3.5% unemployment rate was “well past” the current threshold of 6.5%.

Wall Street reacted favorably to the taping announcement with the Dow Jones Industrials advancing 1.84% closing at 16,167 at the close of business Wednesday (Dec. 18). The S&P 500 also picked up 1.66% to close at 1,810. The NASDAQ followed suit rising 1.15% to 4,070.

The bond market yields also edged higher with 10-year Treasury Note yielding 2.87% as prices declined slightly. Gold, Crude Oil and the U.S. dollar slipped lower on the taper news.