Photo Credit: Reuters/Jason Reed
Follow the economy, not the Fed, was the gist of U.S. Federal Reserve Chairman Ben Bernanke’s guidance to investors over when the central bank would start to taper its $85 billion-a-month bond buying program. While Bernanke came closest to date in offering a timeline for the tapering to start, he still did no more than lay out some possible courses for that process to follow, and repeatedly stressed that the Fed would adapt to financial conditions as it found them.
It would be “appropriate to moderate the monthly pace of purchases later this year,” he said at the press conference that followed the two-day monetary policy meeting under the rubric of the Federal Open Markets Committee. He foresaw “measured steps” through the first half of next year to slow the asset purchases, which could end “around midyear.”
The caveat to all that is an assumption that the Fed’s expectations for an improving economy hold true. The Fed has proved itself overly optimistic in its economic forecasts in the recent past. The caveat is significant, even if it is one Bernanke has repeatedly made.
Much of the recovery the Fed sees coming in the economy hangs on the recovery in the housing market. That is not yet robust. Joblessness is still above where the Fed wants to see it: 5%-6% was Benanke’s number (the unemployment rate in May was 7%; the Fed’s own threshold for tightening, 6.5%). Median incomes are not recovering with the economy as a whole, if anything the reverse — and Bernanke’s explanation that this is a function of a slack labor market was about the least convincing thing he said. The slowdown in inflation, if anything more than transitory, would be a concern, too. The downside risks to the economy may be diminishing, but they have not gone away.
The Chairman’s bluntness in saying that policy adjustments would be made as necessary was not any change of policy, just an attempt to articulate it in a less-nuanced fashion. In the meantime the Fed’s assets purchases will continue unchanged, he stressed.
Bernanke also laid it on thick that the central bank was continuing to stimulate the economy — it was contemplating easing up on the accelerator, not hitting the brakes, as he put it. He also said the Fed would be maintaining a large balance sheet even when it comes time to tighten monetary policy, and implied it would keep its balance sheet swollen for longer than previously thought (perhaps the only substantive policy shift to come out of the news conference). His intention was to support the mortgage-backed securities markets as and when tapering comes.
He has a difficult balancing act to maintain between withdrawing the stimulus without derailing the recovery or spooking skittish investors. They, he hinted, were overreacting. And react they did, pushing stocks down 1% in afternoon New York trade and bond yields up to a 15-month high.
The disconnect between the Fed’s message as delivered by Bernanke and the market’s perception of it remains. Investors will continue to watch the Fed watching the U.S. economy, rather than as Bernanke would have it, the economy itself.
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