Bernanke’s Tapering Talk Backfires Amid Bond Yield Surge
Federal Reserve Chairman Ben S. Bernanke has repeatedly said a reduction in the Fed’s $85 billion in monthly bond purchases wouldn’t mean an end to record easing. Investors are behaving as if they don’t believe him.
The yield on the 10-year Treasury note has risen to 2.15 percent, an almost 14-month high, from 1.63 percent on May 2 as investors bet the Fed will begin trimming bond buying. The surge is undermining Bernanke’s unprecedented effort to hold down borrowing costs and combat 7.6 percent unemployment.
The Fed chairman needs to persuade markets that tapering monthly purchases wouldn’t be a prelude to aggressive policy tightening and ensure rising interest rates don’t choke off the weak U.S. economic expansion, said Michael Gapen, a former section chief at the Fed Board’s Division of Monetary Affairs.
“They are playing with fire when they want to talk about tapering but don’t explain how it fits in with the rest of the exit strategy clearly,” said Gapen, a senior U.S. economist at Barclays Plc. “You risk the premature tightening that you want to avoid.”
Bernanke, 59, will have an opportunity to retune the Fed’s message during a press conference on June 19 after the Federal Open Market Committee concludes a two-day meeting and releases a policy statement. The committee also plans to provide forecasts for economic growth, inflation, unemployment and interest rates.
Bernanke’s comments will follow a rise in the yield on the U.S. 30-year bond to 3.43 percent on June 11, the highest since April 2012. The 30-year bond yield declined 0.06 percentage point to 3.31 percent at 4:42 p.m. New York time.
Investors interpret policy makers’ talk of reduced bond purchases as a signal the Fed is more likely to increase its main interest rate as soon as next year. They see a 37 percent chance the Fed will raise the rate to at least 0.5 percent from zero to 0.25 percent by December 2014, according to prices for federal funds futures contracts.
That’s an increase from about 20 percent probability two months ago. It also contrasts with a majority of 14 Fed officials who forecast in March that the FOMC won’t increase the federal funds rate until 2015 or later. The Fed has held the rate banks charge one another for overnight loans near zero since December 2008.
Bernanke needs to emphasize on June 19 that “policy will remain quite accommodative” even after any reduction in bond buying, said Mark Spindel, chief investment officer at Potomac River Capital, a Washington-based hedge fund with $500 million under management. The Fed chief needs to make clear that, when adjusting monetary policy, “there is a difference between the accelerator and the brake.”
Michelle Smith, a spokeswoman for the Fed, declined to comment.
In testimony to the Joint Economic Committee on May 22, Bernanke said the FOMC “expects a highly accommodative stance of monetary policy to remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.”
Bernanke said policy makers want to see “increased confidence that the labor market is improving and that the improvement is sustainable.” Nearly 8 million people who have part-time jobs want to work full-time, he said.
“High rates of unemployment and underemployment are extraordinarily costly,” he said. “Not only do they impose hardships on the affected individuals and their families, they also damage the productive potential of the economy as a whole by eroding workers’ skills.”
In response to a question from Representative Kevin Brady, a Texas Republican and the committee chairman, Bernanke said the FOMC could consider reducing bond purchases within “the next few meetings” if officials see signs of sustained improvement in the labor market.
The FOMC is more specific with its criteria for raising the fed funds rate, saying it will consider such a move when unemployment falls to 6.5 percent so long as the outlook for inflation doesn’t exceed 2.5 percent.
Bernanke said at his most recent press conference on March 20 that the Fed would adjust its monthly bond buying in a “sensitive way” based on several measures of the labor market, including payrolls, wages and jobless claims.
Non-farm payrolls since September have increased at a monthly average of 190,000, pushing down the unemployment rate to 7.6 percent in May from 8.1 percent in August, a month before the third round of quantitative easing began. The Labor Department’s Job Openings and Labor Turnover Survey showed that the number of people hired climbed to 4.43 million in April. That lags the 5.19 million monthly average of 2007, the final year of the previous expansion.
Investors can’t be sure whether such data come close to satisfying the committee’s desire to see substantial job market gains, said Michael Hanson, senior U.S. economist at Bank of America Corp. in New York.
The Fed “hasn’t been clear on what it’s going to take,” Hanson said. Once policy makers begin reducing monthly bond purchases, “the markets see this as a ball rolling downhill that’s only going to gain steam.”
William C. Dudley, president of the Federal Reserve Bank of New York, cautioned last month that the potency of Fed policy depends on clearly describing how changes in the outlook will influence FOMC decisions.
“There is some risk that market participants could overreact even before normalization begins, when the pace of purchases is adjusted but the level of accommodation is still increasing month by month,” Dudley said on May 21 in New York. “Not only could such responses threaten financial stability, but also they might make it harder to calibrate monetary policy appropriately to the economic situation.”
The comments by policy makers about a possible reduction in bond buying don’t necessarily indicate the Fed will provide less total accommodation. The central bank through its third round of purchases, known as quantitative easing, has pumped up its assets to $3.4 trillion.
“Changing the flow of purchases does not necessarily yield, in the end, a smaller central bank balance sheet,” Boston Fed President Eric Rosengren said in a May 29 speech. “Even if we were to adjust the rate of monthly purchases, the ultimate size of the Fed’s balance sheet would depend on the point of cessation.”
Bernanke and his policy making colleagues are commenting on the potential for tapering bond buying in part because of “unease over the size of the balance sheet,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics in Washington.
In February, Bernanke told lawmakers that the size of the balance sheet risks eroding public confidence in the Fed’s ability to reduce it and may stoke inflation expectations.
At the same time, policy makers’ comments keep “conflicting with the stimulus that they want to deliver to the economy,” said Gagnon, a former associate director at the Fed’s Division of International Finance.
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