Practical Economics


Bernanke Struggles to Clarify Fed’s Intentions

Glenn Somerville

Relax, bond investors. Rates will rise gradually, despite the turmoil over the Fed chief's recent statements.



Federal Reserve Chairman Ben Bernanke is finding out that too much communication can be just as confusing for markets as too little. Since 2006, when he took over as chairman of the nation’s central bank, Bernanke has championed more openness about the Fed’s policymaking thought process. Now, as he tries to provide jumpy financial markets with some guidance on how the central bank will scale back the current exceptional mix of stimulative bond buying and rock-bottom interest rates that it has been applying since 2008, the task is proving tricky.

GOING LONG: Bernanke Got It Right

The flood of information that the formerly secretive central bank now puts out sometimes leads to turmoil — the more so when financial markets are as intently poised to leap into action as they are now, out of fear of missing an interest rate turn.

Bernanke’s first effort to lay out a rough route for paring back the Fed’s bond buying followed a June 18-19 policy-setting meeting and triggered a frenzy in global markets. Investors jumped to the conclusion that his remarks signaled an earlier-than-expected end to near-zero interest rates. September shot to the fore as the predicted date for the Fed to start reducing bond purchases, and bondholders rushed to the exits, dumping holdings and sending rates soaring by about a full percentage point on 10-year Treasury notes.

The earliest the Fed is likely to act is later in the year, however. A September turning point was and remains too early. Instead, it’s likely to be December, and possibly not until next year, before the monetary gurus will move, after they see solid and lasting signs of economic recovery — including more robust labor markets.

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What’s more, easing up on the volume of bond buying isn’t yoked to a hike in official interest rates. The two steps are, in fact, separate elements of a broader Fed drive to reinvigorate the economy by pumping liquidity into it. And there is little likelihood the central bank will start lifting rates before 2015. Edgy market participants confused the two elements.

Now Bernanke is trying again to paint a complete, and nuanced, picture of what’s ahead, telling a blue-ribbon National Bureau of Economic Research crowd that an easy-money policy remains necessary for the foreseeable future. His July 10 speech expressing that view followed release of the minutes from the mid-June Federal Open Market Committee meeting and was clearly a bid to steady spooked market players. The minutes themselves were far from clear. Although they noted that many of the 19 central bank members need to see solid labor gains before tapering off on bond buying, and many saw bond buying continuing into 2014, the minutes also indicated that about half of the Fed members favored ending the economic stimulus program late this year. The split illustrates the divergence of views among policymakers about the best course to follow.

For clarity, listen to Bernanke’s own words. “Highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy,” he told a questioner. That doesn’t indicate an imminent change in either interest rates or quantitative easing.

The takeaway from all this? Bond investors should stay calm, looking for rates to rise gradually over the next one or two years. A turn toward a cycle of higher short-term rates was always part of market expectations, and you can count on the market to overshoot at times. Interest rates will eventually rise, to a level the economy can bear. But relatively slow current and anticipated rates of GDP expansion mean they won’t soar to the stratosphere and stay there. Periods of exceptional volatility are to be expected, however, as price levels seek equilibrium. But keep your eye on the horizon, not on the immediate turmoil.



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