Confusion reigns on Fed plans
Despite a near-uniform consensus on Wall Street that the Federal Reserve would start to withdraw its economic stimulus this month, the central bank surprised strategists by announcing it would indefinitely maintain its bond-buying program at full strength.
Stocks jumped and the 10-year Treasury yield fell.
While the continuation of the stimulus program helps stockmarket investors, the Fed's apparent change of heart sowed confusion in markets around the world. Many on Wall Street were left wondering how they got it so wrong, with several pointing an accusing finger at Dr Bernanke, the Fed chairman, and the central bank's communication strategy.
For his part, Dr Bernanke appeared to put some of the blame on Wall Street.
"The Fed and the market have not been on the same page," said Michael Hanson, senior US economist at Bank of America, and one of the few strategists to have predicted that the Fed would stand pat on its bond buying.
Since May, when Dr Bernanke first signalled that the Fed could start to wind down its efforts to stimulate economic growth, Wall Street has been preoccupied with predicting when and by what degree that would happen. At its June meeting, Fed policymakers said the economy was nearly strong enough to begin doing without the full force of the stimulus program.
As a result, investors spent much of the northern summer adjusting to the idea that the Fed would begin a retreat from its monthly buying of $US85 billion ($90.7 billion) in Treasuries and mortgage-backed securities.
Figuring out what would come next involved navigating in uncharted territory: the breadth and scale of the steps taken by the central bank to get the economy back on its feet in the wake of the financial crisis have been without precedent. The bond-buying programs have helped push up stock prices and kept interest rates low, making it easier for borrowers to take out home and car loans.
The expectation that those programs would soon start to ease has caused interest rates to rise, which has hurt emerging market economies that had come to rely on lower rates.
The recent preparations paved the way for the mixture of confusion and euphoria that broke out after Dr Bernanke's speech.
"In one line: Delay is good policy, the communications strategy is in pieces," Ian Shepherdson, chief economist of Pantheon Macroeconomics, wrote in a note on Wednesday.
The S&P 500 stock index jumped 1.2 per cent to 1725.52 on Wall Street, while the Dow rose nearly 1 per cent to 15,676.94. Both indices reached record nominal closing highs.
Dr Bernanke still suggested that a pull-back could begin later this year, but said Fed officials had determined the economy was not on a strong enough footing to begin adjusting its stimulus this month.
In his news conference, Dr Bernanke appeared to acknowledge that the central bank had gone against the expectations of the market. He said part of the problem was the complexity of the stimulus programs, which made it hard to predict future policy.
"We are dealing with tools that are less familiar and harder to communicate about," he said.
Michael Gapen, chief US economist at Barclays, said he believed the Fed had purposely misled investors to push up interest rates and knock out speculation in risky financial products.
Frequently Asked Questions about this Article…
Markets were expecting the Fed to begin withdrawing its bond-buying stimulus, but Dr Bernanke surprised investors by saying the Fed would indefinitely maintain the bond-buying program at full strength. That surprise sent stocks higher and pushed the 10-year Treasury yield lower, creating a mix of euphoria and confusion across global markets.
The Fed announced it would continue its monthly bond-buying program at full strength rather than starting to wind it down this month. Dr Bernanke did say a pull-back could begin later in the year, but Fed officials judged the economy was not yet strong enough to reduce stimulus.
Following the Fed announcement, the S&P 500 rose about 1.2% to 1,725.52 and the Dow climbed nearly 1% to 15,676.94, both reaching record nominal closing highs. At the same time, the 10-year Treasury yield fell, reflecting the continuing stimulus.
Since May, investors had been adjusting to Fed signals that a taper could be coming and spent months trying to predict timing and scale. The complexity of the bond-buying programs and mixed signals from Fed communications made it hard to read future policy, prompting comments that the communications strategy was in pieces.
The Fed's ongoing bond-buying program has helped keep interest rates low, which makes it easier for consumers to take out home and car loans. By maintaining the program, the Fed is prolonging that low-rate environment for now.
Expectations that the Fed would ease back on its bond purchases had already pushed interest rates higher, and those rising rates hurt emerging market economies that had come to rely on lower global interest rates.
Yes. Michael Gapen, chief US economist at Barclays, said he believed the Fed had purposely misled investors to push up interest rates and curb speculation in risky financial products. Other economists pointed to a breakdown in the Fed–market communication relationship.
Everyday investors should know that Fed announcements can move stock prices and bond yields quickly: continued bond-buying generally supports stocks and keeps rates low, while talk of tapering can push rates up. The article highlights that Fed communications can be unclear, so staying informed about Fed statements and understanding how stimulus affects borrowing costs and global markets can help manage expectations.
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