Fed enters delicate new phase of communication
NEW YORK (Reuters) - Investors' hair-trigger reaction to Federal Reserve Chairman Ben Bernanke's testimony on Wednesday marks a delicate new policy phase for the U.S. central bank in which communication is paramount.
Pitfalls lurk as the Fed approaches the time when it will begin to withdraw its extraordinarily accommodative policies, probably starting some time this year with a tapering of its $85 billion in monthly bond purchases.
The question of when the Fed will act is center stage for investors, who have driven up stock prices since September, when the latest quantitative easing, or QE3, program was launched to spur U.S. hiring and economic growth.
Bernanke's prepared testimony to a congressional committee struck a dovish tone, echoing comments in the previous 24 hours by New York Fed President William Dudley and aiming to calm growing worries that QE3 could be reduced in coming months.
But when Bernanke later answered a question by saying the Fed "could in the next few meetings ... take a step down in our pace of purchases," bond and stock markets reacted with sharp sell-offs.
The shift underscores the difficult task for the Fed, which will want to assuage investors that the process of unwinding the unprecedented level of monetary stimulus will be gradual.
"The complicated task of weaning the baby off the bottle was never going to be an easy one," said Eric Green, head of global rates, FX and commodity research at TD Securities. "Wednesday was one of those days and illustrates the complex messaging Bernanke now faces."
An abrupt run up in longer-term U.S. yields is a worst-case scenario for Fed officials because it could wipe out all the progress they have made easing borrowing costs for Americans in the wake of the 2007-2009 recession.
Notably, on Thursday, the morning after Bernanke's remarks, St. Louis Fed President James Bullard said in a speech that he did not think the Fed was "that close" to talking about exiting its bond purchasing program.
The Fed has said it will keep up QE3 until the labor market outlook improves substantially. Yet it is unclear what would prompt a partial reduction in the pace of bond purchases.
Inflation is below the Fed's target and the unemployment rate remains high at 7.5 percent. Yet the rate has come down from 8.1 percent before QE3 was launched and monthly job growth has averaged more than 200,000 in the last six months.
In a very dovish and consistent tone, Bernanke on Wednesday stressed that more economic traction was needed before the Fed adjusted its bond buying. Yet he added that he was "a bit" more concerned about financial stability, including asset-price bubbles caused by the easy money.
There were more mixed messages from the central bank a few hours later when minutes from its latest policy meeting showed "many" Fed policymakers needed to see better job-market progress before they would slow the purchases, while "a number" of them were willing to do so as early as next month.
U.S. stocks headed lower after the minutes and closed the day down. Early sharp losses on Thursday, however, had nearly dissipated by midday, even though Bernanke's testimony refocused the market's attention on Fed language.
"We are kind of in a situation where all news is bad news in a way when the Fed starts to talk," said Peter Jankovskis, co-chief investment officer at OakBrook Investments LLC in Lisle, Illinois.
One possible message from Bernanke and the Fed minutes is that the central bank will not buy bonds indefinitely in order to manage inflation expectations, said Ward McCarthy, chief economist at Jefferies. Another, he said, is that the Fed is uncomfortable with the market's assumption that the pace of buying is on autopilot at $85 billion.
The New York Fed's Dudley and other officials have increasingly stressed the notion that purchases could be ramped down and then up again in a non-uniform fashion that responds to economic conditions.
Yet they have generally avoided predicting by what dollar increments the pace of QE3 might be adjusted, suggesting that discussion could amplify as the policy change draws closer.
"It seems to me that Bernanke has been getting uncomfortable with how mechanically the market was trading off of Fed policy and he wanted to introduce a little bit of randomness in the equation," said John Brynjolfsson, chief investment officer of hedge fund Armored Wolf.
- South Korea recovers first bodies from inside sunken ferry |
- Japan expands army footprint for first time in 40 years, risks angering China
- Special Report: How the U.S. made its Putin problem worse
- Vice-principal of South Korea school in ferry disaster commits suicide |
- Mediator heads to east Ukraine, seeking surrenders |