Last month the Federal Reserve once again elected to reduce the size of its current quantitative easing program (commonly known as “QE3”). The decision appears to have had zero impact on the stock market.
Investors seem to expect the Federal Reserve will continue cutting back QE3 through the rest of 2014. QE3 began in September 2012 when the Federal Reserve said it would purchase $85 billion in bonds monthly. The latest decision cuts QE3 purchases to $35 billion in bonds monthly beginning in July.
The financial markets were initially nervous last year when the Federal Reserve first announced the QE3 cutbacks. However, the markets have historically not had much of a reaction when the Fed cut back on asset purchases in the past. While the size of QE3 is unprecedented, transitions to periods of tighter monetary policy historically have been accomplished without too much market impact.
The Fed continues to keep a watchful eye on inflation. The inflation rate has been near 1% (give or take) for more than a year now. From the Fed’s perspective, 1% inflation is too low. They believe inflation should be at 2% to promote a healthy U.S. economy. The Fed had been saying it would keep interest rates low, as long as the unemployment rate remained above 6.5%. Now, they are using inflation rates as a key indicator.
The bigger question is whether the economic recovery will hold up without QE3. Many economists predicted the economy would grow 3% this year. Unfortunately, through mid-2014, it seems to be stuck at the 2% pace it has been at for the last 3 years. Last month, the International Monetary Fund said the U.S. economy would only grow 2% this year, down from its earlier forecast of 2.8%.
The Fed may be ending QE3 too early. However, it would appear that the program hasn’t done anything to stimulate economic growth in the past 2 years.