Confusion reigns on Fed plans

Ben Bernanke and the markets are having a hard time understanding each other.

Ben Bernanke and the markets are having a hard time understanding each other.

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.

New York Times

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