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U.S. stocks rally to record after Fed announces cuts to stimulus

U.S. stocks rose, sending benchmark indexes to all-time highs, after the Federal Reserve said it will reduce the pace of its monthly bond purchasesand expressed confidence in the labor market recovery.

Homebuilders rallied after the Fed said it may hold interest rates near zero even if unemployment falls below the 6.5% rate the central bank previously cited as a likely catalyst for an increase.

The Standard & Poor’s 500 Index (CME:SPH14) added 1.7% to 1,811.07 at 4 p.m. in New York, surpassing its previous record close reached on Dec. 9. The Dow Jones Industrial Average climbed 296.50 points, or 1.9%, to an all-time high of 16,171.76. Both gauges posted their biggest gains in two months.

“It’s confirmation that the Fed thinks the economy is strong enough to justify tapering,” David Lafferty, chief investment strategist for Natixis Global Asset Management in Boston, said in a phone interview from Boston. His firm oversees $783 billion. “I’d contrast that with four or five months, when people were afraid of the taper. Now we had better economic data in the past four to six weeks, people were ready for it and markets have adjusted its expectations.”

The central bank announced plans to cut its monthly bond purchases to $75 billion from $85 billion, taking its first step toward unwinding the unprecedented stimulus that Chairman Ben S. Bernanke put in place to help the economy recover from the worst recession since the 1930s.

‘Modestly Reduce’

“In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the committee decided to modestly reduce the pace of its asset purchases,” the Federal Open Market Committee said today at the conclusion of a two-day meeting in Washington.

The central bank added that it “likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below” the Fed’s 2% goal.

The jobless rate fell to 7% in November, a five-year low, as employers added a greater-than-forecast 203,000 workers to payrolls. Unemployment was down from 10% in October 2009, during the recession, and up from 4.4% in May 2007.

‘Very Small’

A majority of economists surveyed by Bloomberg on Dec. 6 estimated that the central bank would delay tapering until next year. Even so, 34% of the respondents projected the Fed would announce reductions in bond purchases today, the survey showed, double the percentage in a Nov. 8 poll.

Bernanke is scheduled to retire at the end of January. Vice Chairman Janet Yellen, who may win Senate confirmation this week to replace him, has been a supporter of the bond-buying policy. The FOMC next meets Jan 28-29.

“While the Fed explicitly states they’re trimming their asset purchases, they continue to re-affirm their expectations of a ‘highly accommodative’ stance on monetary policy and exceptionally low rates,” said Yousef Abbasi, market strategist at JonesTrading Institutional Services LLC, a Westlake, California-based broker. “No one seems unnerved even though the majority hadn’t forecasted a taper in December.”

December Returns

The rally erased the monthly loss for the S&P 500, with the index up 0.3% in December. The final month of the year has been the second-best for U.S. equity returns, according to data compiled by Bloomberg that starts in 1928. The average gain for the month is 1.5%, more than twice the overall monthly mean of 0.6%.

The equity benchmark has surged 27% this year, on course for the biggest annual gain since 1998, as the Fed maintained its stimulus and economic data exceeded expectations. The gauge rallied 167% from a 12-year low in 2009 through yesterday.

The Chicago Board Options Exchange Volatility Index plunged 15% to 13.83, erasing an early gain of 3.3% and halting a six-day rally.

Source: Bloomberg

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