Optimistic Fed Outlines an End to Its Stimulus

Ben Bernanke

In his post-FOMC press conference, Fed chief Ben Bernanke unveiled to reporters his plan for tapering asset purchases, indicating they are expected to begin later this year and end at some point toward the middle of 2014, if and only if the economy accompanies the Fed’s “moderately optimistic forecast.” Despite his best attempts at telegraphing to the market that tapering still means increasing policy accommodation, stocks and Treauries sold off hard, with the Dow clocking in triple digit losses and the 10-year note yield jumping to 2.34%.

Bernanke delivered the show most Fed watchers expected, and came out guns blazing after the FOMC statement revealed “diminished” downside risks to the economy. If things work out as expected over the next six to twelve months, the Fed will begin to draw-down its asset purchases, currently running at a pace of $85 billion a month, and end them at some point next year, when the unemployment rate hits 7%.

Effectively, this is the first step in the Fed’s exit policy, and as Bernanke has repeated tirelessly, it is contingent on incoming economic data. We wouldn’t be shrinking the portfolio but slowing the pace at which it grows, Bernanke told reporters as the market ignored him, with equities tanking and bond yields surging. The Fed is lifting its foot off the gas, Bernanke explained, not hitting the brakes.

After a muted reaction to the FOMC statement, the market sold off sharply during and after Bernanke’s press conference. The Dow finished the day 206 points, or 1.4%, lower, at 15,112 while the S&P 500 dropped 23 points, 1.4%, to 1,629 in a slide that may be the start of an unwinding “Bernanke put” or the implied floor under the market created by the central bank’s aggressive stimulus efforts. Treasury yields surged with the 10-year note up to 2.34% and five-year notes jumping to 1.24%.

The market has made it clear that it sees the rate or flow of asset purchases as indicative of the state of accommodation, selling off big when Bernanke first indicated the taper was in the cards on May 22 before Congress, and tanking further on Wednesday as he detailed the Fed’s plan. The U.S. dollar gained dramatically against the euro and the Japanese yen, while gold and oil fell hard.

At the same time, the Chairman did his best in trying to separate the tapering of quantitative easing from the rest of their exit strategy. Currently, the Fed has set a 6.5% unemployment rate threshold to begin to raise rates, as long as inflation remains below 2.5%, but Bernanke admitted this is still too high, noting that majority of the FOMC doesn’t expect to firm monetary policy (i.e. hike rates) until 2015.

On the Fed’s exit strategy, Bernanke did give one clue: mortgage-backed securities will most likely be monetized. Interestingly, when asked if the Fed “is the market [for MBS],” Bernanke rejected that notion, noting the Fed isn’t disrupting price discovery and liquidity in those markets. The Fed does take credit for stimulating a housing recovery that is pushing home prices higher, fueling construction jobs, adding to homeowners’ net worth, and taking stocks in homebuilders like KB Home and Lennar LEN -3.74% to multi-year highs.

The Chairman also spoke of global volatility and when asked about Japan noted markets were reacting to the Bank of Japan’s “aggressive” actions intended to break a vicious cycle of deflation. Supporting the job of Haruhiko Kuroda, he praised Japanese policymakers for trying to revitalize their economy, and said a global slowdown in emerging markets may be partially responsible for changing fund flows.

Bernanke’s comments were consistent with what he told Congress back in May, when he indicated tapering could come over the coming meetings but that accommodation would still be necessary. He did make his game plan clear, noting QE will begin to be withdrawn soon if the economy continues to move forward, but he hasn’t been able to get markets on his side as to what tightening actually means.

Source : Forbes.


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