Federal Reserve Stimulus Ending?

The fiscal cliff relief rally was cut short on Wall Street Thursday by release of the minutes of the December Federal Reserve meeting. Minutes of the meeting indicated that some members of the Federal Reserve Board wanted to end the Fed’s bond buying spree sooner rather than later.

The Federal Reserve has been buying about $85 billion a month in U.S. Treasuries and mortgage securities in the open market to keep interest rates low and pump money into the U.S. financial system.

The worry is that U.S. financial markets have grown accustomed to the Fed being in the market constantly, giving it support. The flip side is the Fed weaning the markets off its support is good news. It means the policy makers at the Federal Reserve are growing more and more confident that the U.S. economy is strengthening and will be able to stand on its own two feet.

However, it is unlikely the Fed’s support for markets will end soon. In September, in an unprecedented move, it linked its bond buying program to the U.S. unemployment. The Fed pledged to continue the program until the unemployment rate dipped below 6.5%. The rate is currently 7.8%.

Even when the Fed decides it’s time to end the bond buying program, it is not likely to cut the financial markets off cold turkey. Michael John Materasso, portfolio manager at Franklin Templeton Institution, believes the Fed will wean the markets off stimulus in a gradual manner so as to not roil the markets.

The Fed minutes were a message to the markets to not expect stimulus forever. As Sam Chandan, president and chief economist with Chandan Economics, said, “If the market believes that this [easing] is going to go on forever, that’s a pretty dangerous thing.” So in effect, the Fed is merely trying to balance the risks in the financial markets.

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