The Economy

The Fed has concluded its asset-purchasing program thanks to an improving labor market. Here's what QE3 has meant to investors and the economy.

After spending trillions of dollars on bond purchases since the end of the Great Recession — to keep interest rates low to boost spending, lending, and investments — the Federal Reserve ended its stimulus program known as quantitative easing.

The central bank’s decision to stop buying billions of dollars of Treasury and mortgage-related bonds each month comes as the U.S. economy has shown signs of recent improvement.

U.S. gross domestic product grew an impressive 4.6% last quarter. And while growth dropped at the start of this year, thanks to an unusually bad winter, the economy expanded at annual pace of 4.5% and 3.5% in the second half of 2013.

Meanwhile, employers have added an average of 227,000 jobs this year and the unemployment rate rests at a post-recession low of 5.9%. It was at 7.8% in September 2012, when this round of quantitative easing, known as QE3, began.

What this means for interest rates
Even with QE over, the Fed is unlikely to start raising short-term interest rates until next year, at the earliest.

In part due to the strengthening dollar and weakening foreign economies, inflation has failed to pick up despite the Fed’s unprecedented easy monetary policy.

And there remains a decent bit of slack in the labor market. For instance, there are still a large number of Americans who’ve been unemployed for 27 weeks or longer (almost 3 million), and the labor-force participation rate has continued its decade long decline. Even the participation rate of those between 25 to 54 is lower than it was pre-recession.

What this means for investors
For investors, this marks the end of a wild ride that saw equity prices rise, bond yields remain muted, and hand wringing over inflation expectations that never materialized.

S&P 500:
Equities enjoyed an impressive run up after then-Fed Chair Ben Bernanke announced the start of a third round of bond buying in September 2012. Of course the last two times the Fed ended quantitative easing, equities faced sell-offs. From the Wall Street Journal:

The S&P 500 rose 35% during QE1 (Dec. 2008 through March 2010), gained 10% during QE2 (Nov. 2010 through June 2011) and has gained about 30% during QE3 (from Sept. 2012 through this month), according to S&P Dow Jones Indices.

Three months after QE1 ended, the S&P 500 fell 12%. And three months after QE2 concluded, the S&P 500 was down 14%.

10-year Treasury yields:

As has been the case for much of the post-recession recovery, U.S. borrowing costs have remained low thanks to a lack of strong consumer demand — and the Fed’s bond buying. Many investors paid dearly for betting incorrectly on Treasuries, including the Bill Gross who recently left his perch at Pimco for Janus.

10-year breakeven inflation rate:

A sign that inflation failed to take hold despite unconventionally accommodative monetary policy is the so-called 10-year breakeven rate, which measures the difference between the yield on 10-year Treasuries and Treasury Inflation Protected Securities, or TIPS. The higher the gap, the higher the market’s expectation for inflation. As you can see, no such expectation really materialized.

Inflation:

Despite concern that the Fed’s policy would lead to run-away inflation, we remain mired in a low-inflation environment.

Unemployment Rate:

The falling unemployment rate has been a real a bright spot for the economy. If you look at a broader measure of employment, one which takes into account those who’ve just given up looking for a job and part-time workers who want to work full-time, unemployment is elevated, but declining.

Compared to the economic plight of other developed economies, the U.S. looks to be in reasonable shape. That in part is thanks to bold monetary policy at a time of stagnant growth.

Indeed, many economists now argue that the European Central Bank, faced with an economy that’s teetering on another recession, ought to take a page from the Fed’s playbook and try its own brand of quantitative easing.

Some central bankers have called for raising rates sooner rather than later. Recent economic data — and the huge stock market sell-off — should dampen those calls.

There have been two presidential inaugurations and six Super Bowl champions since interest rates were effectively lowered to 0%. Recently, some Federal Reserve officials have said they expect to raise rates by the middle of next year thanks to a decently expanding economy and stronger job growth.

Some central bankers, though, think the middle of 2015 is too late and have been pushing to increase borrowing costs sooner. Esther George, President of the Kansas City Fed, said as much in a speech earlier this month, and two members of the Federal Open Market Committee voted bristled against easy monetary policy in their most recent meeting.

But with developed economies around the world showing dismal growth and less-than-stellar economic metrics here at home — punctuated by a rapidly declining stock prices (the stock market is, after all, a reflection of the market’s forecast for the economy six to nine months down the road) — it might be time for these inflation hawks to quiet down.

“Until we see wages expanding faster than the rate of inflation, and significantly so, we won’t see much in the way of inflation pressure,” says Mike Schenk, Vice President of Economics & Statistics for the Credit Union National Association. “Why raise rates if you don’t have inflation?”

Inflation Hawks

Dallas Fed President Richard Fisher voted against the most recent monetary action policy, according to minutes of the meeting, due to, among other factors, the “continued strength of the real economy” and “the improved outlook for labor utilization.”

Earlier this month, Philadelphia Fed President Charles Plosser said that he’s “not too concerned” about inflation growth below the Fed’s 2% target and joined Fisher in voting against the Fed policy because he disagreed with the guidance that said rates will stay at zero for “a considerable time after” the Fed ends its unconventional bond-buying program later this month.

George, meanwhile in a speech earlier this month, said Fed officials should begin talking seriously about raising rates since “starting this process sooner rather than later is important. If we continue to wait — if we continue to wait to see full employment, to see inflation running beyond the 2% target — then we risk having to move faster and steeper with interest rates in a way that is destabilizing to the economy in the long term,” according to the Wall Street Journal.

Jobs

The jobs environment has been improving in recent months. The economy added almost 250,000 jobs in September and the unemployment number fell to a post-recession low of 5.9%. But the unemployment number doesn’t tell the whole story.

If you look at another metric that takes into account workers who only recently gave up looking for a job and part-time employees who want to work 40 hours a week, the situation is much worse. Before the recession, this broader unemployment rate sat at around 8%. It’s now at almost 12%. There are still about three million workers who’ve been unemployed for longer than 27 weeks, up from around 1.3 million at the end of 2007.

Inflation

Right now, and for some time, there has been very little inflation. Prices grew 1.7% over the past year in August, per the Bureau of Labor Statistics’s Consumer Price Index. Even the Fed’s preferred inflation tracker, the PCE deflator, showed prices gain 1.5% compared to 12 months ago.

Wage growth is likewise stalled. Taking into account wages and benefits, workers have only seen a 1.8% raise. It’s just difficult to have inflation in a low interest rate environment without wage growth.

St. Louis Fed President James Bullard recently said that the Fed should consider postponing the end of its bond-buying program. “Inflation expectations are declining in the U.S.,” he said in an interview yesterday with Bloomberg News. “That’s an important consideration for a central bank. And for that reason I think that a logical policy response at this juncture may be to delay the end of the QE.”

Europe

European economic woes aren’t helping. Germany, Europe’s largest economy, recently cut it’s growth forecast, now only expects to grow by 1.2% in 2014 and 2015. Sweden and Spain saw prices actually decline in August, and now there’s fear that the euro zone will endure a so-called triple-dip recession. The relative prowess of the American economy compared to Europe’s has strengthened the U.S. dollar, thus making our exports less competitive.

Look, the U.S. economy isn’t about to go off a cliff. Not only did we see growth of 4.6% last quarter, but employers are adding jobs at a decent clip and the number of workers filing first-time jobless claims fell to the lowest level since 2000, per the Labor Department.

But with low inflation and European struggles to achieve anything close to robust growth, raising interest rates anytime soon doesn’t appear likely.

The unemployment rate is the lowest since 2008.

The economy added 248,000 jobs in September, the Bureau of Labor Statistics reports, beating analyst expectations and improving significantly over August’s disappointing numbers. The bureau’s last monthly release showed the U.S. only adding 142,000 jobs, the fewest in eight months. Friday’s data could help quell any fears of a worsening employment climate.

Today’s nonfarm payroll report also showed the unemployment rate falling to 5.9%, down from 6.1% in August and the lowest since July of 2008. The labor force participation rate — the percentage of the workforce that is either employed or actively looking for work — remained mostly static at 62.7% as older Americans continue to drop out of the work force. The unemployment rate has dropped by 0.7% in 2014, but still remains about 1.5 percentage points higher than its pre-crisis lows.

Despite an increase in hiring, average hourly earnings did not budge. Wages growth was static in September, and hourly wages have increased just 2% over the year.

Economists and investors have been closely watching monthly jobs numbers, partly to glean insight into when the Federal Reserve will begin to raise interest rates. Fed chair Janet Yellen has made employment growth a key factor in determining monetary policy, and repeatedly cited labor market slack as a reason for keeping rates at historic lows. However, as MONEY’s Taylor Tepper notes, Yellen is unlikely to raise interest rates in the near future due to inconsistent employment numbers and concerns over a shaky global economy, particularly in Europe.

MONEY’s Pat Regnier points out that while consumer spending has largely recovered since the housing crash, construction and government spending has not. Until public spending begins to return to pre-recession levels, job growth may continue to be especially sluggish. September showed little increase in government spending.