Fed Tapering Dependent On U.S.Economy Improving in 2013

qeFollowing the close of the Federal Reserve’s Federal Open Market Committee’s (FOMC) two- day meeting in Washington D.C. Federal Reserve Chairman Bernanke spoke to reporters in a press conference.

Digesting Chairman Bernanke’s closing remarks and answers to journalists is a complicated endeavor because there are lots of moving parts and economic factors in play as the market attempts to summarize the prevailing narrative about when the Fed may decide to taper its monthly 85 billion quantitative easing program that has helped to lower interest rates and stimulate the U.S. economy.

U.S. equity markets sold off when Bernanke’s press conference began, and bond yields spiked to a 15 month high, indicating that the market perceived the chairman’s comments as suggesting a quicker tapering of Fed bond purchases perhaps as early as 2013, although the chairman admitted that the Fed will continue to evaluate economic conditions and risks as they “evolve”.

“Overall, the Committee believes the downside risks to the outlook for the economy and the labor market have diminished since the fall, but we will continue to evaluate economic conditions and risks as they evolve” Bernanke said.

Bernanke explained the Fed could begin to “moderate” or taper its bond purchases later this year, if its forecasts for inflation moves to their 2 percent longer term goal and the unemployment rate falls to around 7 percent as Fed policymakers forecast.

“If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear. In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7%, with solid economic growth supporting further job gains, a substantial improvement from the 8.1% unemployment rate that prevailed when the committee announced this program” Bernanke said.

Altering The Federal Reserve’s Portfolio, “Unlikely To Be Relevant To Actual Policy For A While”  Bernanke Says

Responding more specifically to concerns about the likelihood of altering the Fed’s Treasury portfolio with mortgage backed securities, Chairman Bernanke said that reducing or eliminating residual mortgage backed  holdings are unlikely to occur “for quite a while” with no clear timetable spelled out.

“While participants continue to think that, in the long run, the Federal Reserve’s portfolio should consist predominantly of Treasury securities, a strong majority now expects that the Commission will not sell agency mortgage backed securities (MBS) during the process of normalizing monetary policy, although in the longer run limited sales could be used to reduce or eliminate residual/MBS holdings. I emphasize that, given the outlook and the Committee’s policy guidance, these matters are unlikely to be relevant to actual policy for quite a while” Bernanke said.

Later in the press conference, Bernanke explained that the Committee could even step- up or increase the pace of its asset purchases if the labor market becomes less favorable.

“If the outlook becomes less favorable, on the other hand, or if financial conditions are judged to be inconsistent with further progress in the labor markets, reductions in the pace or purchases could be delayed; indeed, should it be needed, the Committee would be prepared to employ all of its tools, including an increase in the pace of purchases for a time, to promote a return to maximum employment in a context of price stability” Bernanke said.

Bernanke used analogy of the Fed pushing on the accelerator, trying to get the economy to go faster. Any slowing in the rate of purchases is akin to letting up on the gas pedal as the car picks up pace.

“To return to the driving analogy, if the incoming data support the view that the economy is able to sustain a reasonable cruising speed, we will ease the pressure on the accelerator by gradually reducing the pace of purchases” Bernanke admitted.

“However, any need to apply the brakes…that is, to tighten monetary policy by raising interest rates, is still far in the future” Bernanke said.

 

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