Today, the Federal Reserve’s monetary policymaking body, the Federal Open Market Committee (FOMC),
shocked market participants and central bank observers by refraining from reducingthe pace of monthly bond purchases it makes under the open-ended quantitative easing program it introduced exactly a year ago.
The consensus on Wall Street was that the FOMC would elect to taper its monthly bond buys to $US75 billion from the current $US85 billion pace. When the FOMC released a statement at 2 p.m., saying it isn’t ready to taper because it is awaiting “more evidence that progress [in economic growth] will be sustained before adjusting the pace of its purchases,” stocks soared, bonds soared, gold soared, and the dollar tanked as traders recalibrated their bets toward continued easy money from the Fed.
The biggest reason the FOMC elected not to announce a taper at the conclusion of this month’s policy meeting, according to Fed chairman Ben Bernanke at today’s press conference: The surge in interest rates since the last FOMC presser in June, when Bernanke himself came out guns blazing with the notion that tapering would happen later in the year.
Bernanke called the FOMC’s decision not to taper this month a “precautionary step,” suggesting that Fed officials were “avoiding a tightening until the economy is growing the way we want it to be.”
And when asked about how U.S. Treasury yields collapsed in response to today’s statement, Bernanke said, “To the extent our policy decision today makes conditions just a little bit easier, that’s desirable.”
He also asserted during the presser that low interest rates were, in fact, the main benefit of the central bank’s expansionary monetary policies in recent years.
In other words, the Fed head recognised that the language in the FOMC’s June 19 statement and the tone of his own subsequent press conference clearly had an unanticipated, undesirable effect on financial markets and the economy, and he felt the need to reverse some of that today by going against the consensus and leaving the current quantitative easing program as-is.
Bernanke and the rest of the FOMC have stated several times this year that the eventual first reduction in bond purchases would be predicated on sustained improvements in the labour market. Lately, however, labour market gains have faltered.
The U.S. economy added only 169,000 workers to nonfarm payrolls in August, below consensus estimates for 180,000. July payroll growth was revised down to 104,000 from 162,000.
Meanwhile, the housing market recovery that was the big story at the beginning of the year has faltered, and lately, some of the data have been outright bad. Many suspect the surge in interest rates this summer has dampened homebuying activity.
So what exactly did Bernanke say in June that caused interest rates to surge?
At the time, the FOMC revised up its economic forecasts — implying a quicker economic recovery, meaning tapering was closer than previously assumed — and even laid out a roadmap for tapering, saying bond buying would likely be reduced later in 2013 if the economic data continued to improve like it had been doing.
But Bernanke didn’t stop there. Interest rates had already been rising since May, and many were wondering how the FOMC would react to such developments, given their potentially negative implications.
When asked about the rise in rates at the June presser, Bernanke said, “Yes, rates have come up some. That’s in part due to more optimism — I think — about the economy. It’s in part due to perceptions of the Federal Reserve. The forecasts that our participants submitted for this meeting, of course, were done in the last few days, so they were done with full knowledge of what happened to financial conditions. Rates have tightened some, but other factors have been more positive — increasing house prices, for example.”
Little did Bernanke know at the time that in effect, he had just green-lit a bigger sell-off in the bond market (and attendant rise in interest rates) than the one that preceded that June meeting, and it clearly did not pan out as the FOMC would have liked.
Fast forward to today. It’s pretty clear that Bernanke and the Committee are watching interest-rate developments pretty closely. Hence, the decision not to taper.
As Bernanke pointed out during the presser, “I don’t recall stating that we would do any particular thing at this meeting.”