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18 Sep, 2013 18:10

America clings to $85bn lifeline, Fed keeps stimulus

America clings to $85bn lifeline, Fed keeps stimulus

In an unexpected move, the Federal Reserve decided not to put the brakes on its easy money policy, and will keep bond purchases at $85 billion per month.

Chairman Ben Bernanke said at the press conference after the meeting that there is “no fixed schedule” or “magic number” for when the Federal Reserve will begin to slow or end its bond purchases.

The decision reached at the end of Wednesday’s two-day meeting of the Federal Open Market Committee (FOMC) came out of the blue, as Chairman Ben Bernanke gave strong hints in August and July that the Fed would decide to begin tapering its stimulus.

“What we will be looking at is the overall labor market situation, including the unemployment rate but other factors as well. There is no magic number,'' he said.

Bernanke clarified that the program will not necessarily end when unemployment reaches seven percent.  

With economic recovery still only slightly picking up, reducing the purchases, even by $10 billion, would have risked wiping out the success achieved in the last four years, and a possible return to dangerous industry bubbles and high inflation.To counter this threat, the Fed will keep official interest rates low.

Unemployment, currently at 7.3 percent, is at its lowest since 2008, but it isn’t clear if the record-low rate is a reflection of robust recovery or cyclical. Inflation is still running below the Fed’s 2 percent target.

“We expect them to finish tapering in March, in time for the unemployment rate to fall below 7 percent," Societe General currency strategist Kit Juckles wrote in a note to clients before the decision was announced. 

Forecast growth for 2013 is between 2.3 and 2.8 percent, but real growth is closer to 1.8 percent for the first half of 2013. Growth is sluggish, but much more robust compared to the EU, which posted 0.3 percent growth for Q2.

The decision coincides with the 5-year anniversary of the collapse of Lehman Brothers, and the financial collapse that prompted the Fed to pump the economy with over $3.5 trillion in bond purchases and a cut in overnight rates to zero.

Choosing to keep the bond purchases at $85 billion of cash injection per-month, split as $40 billion mbs and $45 billion treasuries, comes before President Obama takes on the Republicans in negotiations over raising the debt-ceiling, which he plans to boost in mid-October once the US hits its spending limit. The government has amassed $16.7 trillion in debt. The deadline for extension is November 2.

If Congress doesn’t extend the debt ceiling, the US could be forced to default on debt and the government could shut down, an option Obama has sworn against.

Global reach

This afternoon’s decision has market implications that reach far beyond America’s shores.   

BREAKING: Dow Jones industrial average hits record after Fed keeps stimulus in place; Bonds, gold rise.

— The Associated Press (@AP) September 18, 2013

Though following the decision stock rose sharply, ahead of it emerging markets tumbled, worried America's cuts could have drastic spillover effects. Billions fled emerging markets on the expectation dollar-based investments would yield higher returns after the probable cuts.

“Emerging markets are backing off, and I really think we will have a  poor year in 2014. The good news is if we have another year or 2 of slowed growth, we may be a in a stronger position for more robust recovery at a later stage, looking at 2017 or 2018,” Lars Christensen, CEO at Saxo Bank told RT in an interview.

“I think the economy will weaken again, relatively soon, we will have maybe one more quarter of rising equity markets and then we’ll hit a top and back off again,” Christensen concluded.

Summer's over

Bernanke’s departure as Chairman in January 2014 had been expected to ‘rush’ the Fed’s decision to start winding-down under Bernanke’s tenure instead of waiting for a new head.

Leading candidate, and Obama-favorite Larry Summers, withdrew his name for consideration on Sunday, leaving Janet Yellin, 67, the moderate vice chairwoman of the central bank, as the likely successor.

A Yellin decision is seen as a safer, smoother, move to Summers, as colleagues fear he would have dismantled the stimulus too quickly and aggressively. Asian markets advanced on Summer’s exit, as the cash-cut off could have a nasty spill over effect on emerging markets.

Yellin, who chaired the White House Council of Economic Advisers under the Clinton administration, would be the first woman to head the Federal Reserve.