The US Federal Reserve sprung a surprise on markets by keeping its asset purchases steady at $85bn a month as it cut growth forecasts for 2013...
Investors reacted sharply, with stocks rising to a record, while gold and oil prices shot higher as bond yields and the dollar dropped.
“This is not what we expected however it is, from the Fed’s point of view, understandable,” said Dan Greenhaus, chief global strategist at BTIG.
The S&P 500 rose 0.9 per cent to a new all-time high of 1,718.19, after the market was a touch lower ahead of the statement.
The yield on 10-year Treasury notes dropped to 2.74 per cent from 2.87 per cent moments after the FOMC statement was released.
The dollar eased by around 1 per cent versus the Japanese yen and euro. Gold rose 2.4 per cent, or $31.94 an ounce to $1,342.
Despite expectations that the Fed would start to taper its third round of quantitative easing, the rate-setting Federal Open Market Committee said it would “await more evidence that progress will be sustained before adjusting the pace of its purchases”.
The decision suggests that the Fed was alarmed by the sharp rise in long-term interest rates that followed its June announcement of a likely scenario for tapering QE3 and by the prospect of a big fiscal showdown in Congress in the coming weeks.
“The tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labour market,” said the FOMC in its statement.
The decision to delay tapering sparked a rally in markets and sent a strong signal that the Fed is still concerned about the economy and wants to see lower long-term interest rates. A taper is still likely in the coming months since the Fed explicitly said it is waiting for more evidence of sustained progress before acting.
“Asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s economic outlook as well as its assessment of the likely efficacy and costs of such purchases,” it said.
The Fed will continue to purchase mortgage-backed securities at a pace of $40bn-a-month and Treasury securities at a pace of $45bn a month. It made no change to its 6.5 per cent unemployment rate threshold for a rise in interest rates. The vote for the decision was 9-1 in favour.
One factor in the decision may have been a downgrade to the FOMC’s growth forecasts for this year and next. The Fed now expects growth of 2.2 per cent in 2013 compared with a June forecast of 2.5 per cent; and 2014 growth of 3 per cent compared with a June forecast of 3.3 per cent.
In a strong signal that the Fed intends to keep rates low for a long time into the economic recovery, the median FOMC official estimated that interest rates would be 1 per cent at the end of 2015 and 2 per cent at the end of 2016.
The interest rate forecast for 2016 is low even though the Fed expects the economy to be close to full employment by then. It predicted an unemployment rate of 5.7 per cent at the end of 2016 compared with a long-run equilibrium of 5.5 per cent.
When the economy is fully recovered, the Fed expects an interest rate of 4 per cent, so the forecast shows how it expects lingering damage from the recession to result in a slow return to normal.
The Fed said that economic activity “has been expanding at a moderate pace” while the unemployment rate “remains elevated”.
“Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labour market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy,” it said.
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