Markets Got Bernanke's Message
Ben Bernanke's comments today gave every indication that the Federal Reserve will keep monetary stimulus going for a long time. If its economic projections prove correct, it won't take its foot off the gas pedal by stopping new bond purchases until mid-2014. And it doesn't plan to start raising its interest-rate target until long after that, possibly until well after the unemployment rate has fallen to 6.5 percent.
So why did the bond market react as if Bernanke had signaled higher interest rates ahead? The yield on the 10-year Treasury note stood at about 2.34 percent as of 4 p.m., up 0.14 percentage point since the Fed released its policy statement at 2 p.m. Over the same period, the Dow Jones Industrial Average fell more than 200 points. Did markets fail to understand what Bernanke was trying to say?
Probably not. Rather, the market's moves suggest that investors were hoping for even more dovish comments from Bernanke. Call it revealed expectations.
In the weeks before the Fed meeting, the utterances of policy makers had raised concerns that the central bank would start cutting back on bond purchases, known as quantitative easing, earlier than previously thought. The jitters caused interest rates to rise, effectively counteracting the purpose of easing, which is to stimulate the economy by keeping long-term interest rates low.
In such a situation, one might expect Bernanke to try to talk rates back down again. One way to do this would be to pledge that the Fed wouldn't taper its bond purchases anytime soon, that the party would keep going.
Instead, Bernanke offered chilling clarity: The Fed is aiming to reduce the monthly size of its bond purchases this year and end them by mid-2014, at which point it expects the unemployment rate to be at 7 percent. The plan will change depending on the economic outlook, but the direction is clear.
For markets, Bernanke's clarification is probably a useful reality check. If investors come to believe interest rates will be low forever, they will get themselves into positions that can lead to disaster when that perception proves untrue. Even at 2.34 percent, the 10-year Treasury yield is still very low by historical standards.
It's another question whether the Fed's policy, now clarified, is correct. The recovery is still weak, inflation is running well below the Fed's target, and the federal budget sequestration will be weighing on growth. It's possible that promising to prolong the party would have been the better thing to do.
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