On Wednesday, Ben Bernanke came out guns blazing.
He said that plans to “taper” the pace of Fed purchases were going ahead, and that the rise in interest rates was not a big concern to the Fed.
And so the market tanked.
What was Bernanke going for?
According to Jefferies David Zervos, this is really all about injecting a little bit of uncertainty into the market to ward off excessive speculation.
[Wednesday’s] pronouncements appear to be a conscious effort to inject uncertainty into a fixed income market that feeds on certainty. He was taking a cue from the great Hyman Minsky. By acting against a market that had become too complacent, he was attempting to force out the dangerous and excessive leverage in the system. And while that may feel a little painful right now, we may end up being very thankful that the Committee took the actions it did Wednesday in the name of preserving future financial stability. Our path to recovery does not rely on 6 guys and Bloomberg levering up spready EM, mortgage or corporate debt.
Our recovery comes from individuals taking on real investments, in real economic endeavours. Increasing the funding opportunities for companies that innovate, put a real return on capital, generate real growth and create real jobs is the primary goal of QE. That is the portfolio balance channel at work. And the side effects related to too much leverage in bond markets have been a thorn in the side of developed market monetary policy implementation for decades. The Fed seems to have learned this lesson and it has decided to purge some of the QE demons from the fixed income markets early, before its too late and we have a souped-up version of 1994 on our hands.
The beauty, says Zervos, is that the Fed is still there to ease further if needed:
If economic prospects sour, they will buy more bonds and stay lower for longer. Ben said as much Wednesday. So the “Bernanke Put” is very much alive and well.