The S&P 500 and the Dow rallied to record highs on Wednesday after Federal Reserve Chairman Ben Bernanke announced that the central bank will maintain its $85 billion quantitative easing program to help support the U.S. economy.
The U.S. 10-year Treasury yield dropped 5.08 percent on the news to 2.71 from 2.87 percent earlier in the day before Fed Chairman Bernanke addressed a packed room of surprised economists and business reporters.
The U.S. dollar plummeted to a seven-month low against a basket of major currencies while gold rallied 4.03 percent.
Characterizing the U.S. economy as proceeding at a “moderate pace” Bernanke said that the “tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and the labor market.”
In what appears to be an indirect reference to Washington D.C. lawmakers over federal government sequester cuts and the looming debt ceiling, Bernanke admitted, “federal fiscal policy continues to be an important restraint on growth and a source of downside risk” and later explained, “the extent of effects of restrictive fiscal policies remains unclear, and upcoming fiscal debates may involve additional risks to financial markets and to the broader economy.”
Bernanke expressed concern about inflation running below the Committee’s 2 percent longer-term objective and acknowledged the labor force participation rate fell by about 0.3 percentage points over the past year with real wages remaining about flat.
“With unemployment still elevated and inflation projected to run below the Committee’s longer-run objective, the Committee is continuing its highly accommodative policies” Bernanke said.
Changing the Roadmap
Most economists and investors were expecting the Federal Reserve to announce some form of reduction or “taper lite” with the pace of the Fed’s $ 85 billion quantitative easing program which consists of $ 40 billion mortgage backed securities and $ 45 billion in Treasuries that has helped to drive interest rates lower, giving relief to homeowners in the housing market, lowering interest rates for the automobile industry, and reducing the level of interest the U.S. government pays with its massive $16 trillion dollar national debt.
Through the Fed’s three rounds of quantitative easing since the economic crisis erupted in 2008, the Federal Reserve has expanded its balance sheet by 3.6 trillion and is heading towards unchartered waters in a thick fog as it reluctantly weighs tapering the pace of its asset purchase program, a move that has sparked more controversy while the Fed gives out little clear signals to the market about how their bond buying expedition will end.
Since mid-May Chairman Bernanke has provided the market with mixed signals about the data-dependent benchmarks the Fed uses when determining how it plans to unwind its large quantitative easing program.
Chairman Bernanke’s comments on May 22nd clearly indicated that the rate of the Fed’s bond purchases could slow in the next few meetings while he also made it clear that some Fed members were willing to scale back the pace of the Fed’s bond buying purchases as early as June.
The yield on the 10 yr. Treasury spiked on that news and accelerated further in June after Bernanke spoke to reporters in June wherein he provided a roadmap for Fed unwinding its $ 85 billion quantitative easing program.
Nebulous Roadmap To Exit QE
After stating that the Fed first wants to reach its 2 percent inflation objective, Bernanke later explained the Fed policy guidelines that are used to determine the correct time to end its quantitative easing program.
“When asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced this program” Bernanke said to reporters in June.
During yesterday’s September Fed policy address to reporters, Chairman Bernanke handed the market a different roadmap for unwinding its quantitative easing program while stating the Fed’s program is “not on a preset course.”
“There is no fixed calendar, schedule. I really have to emphasize that. If the data confirm our basic outlook, if we gain more confidence in that outlook and we believe that the three-part test that I mentioned is, indeed, coming to pass, then we could move later this year” Bernanke explained.
“We could begin later this year. But even if we do that, the subsequent steps will be dependent on continued progress in the economy. So we are tied to the data” he added.
Bernanke reversed course and said that the 7 percent unemployment rate is “not a great measure of the state of the labor market” and “not necessarily a great measure in all circumstances of the state of the labor market overall.”
While tossing out the significance of the 7 percent unemployment rate “stop sign” that is not far away from August’s 7.3 percent unemployment rate, Bernanke said that the Fed will instead place more emphasis on the labor outlook.
“The criterion for ending the asset purchases program is a substantial improvement in the outlook for the labor market.” he said.
Short -Term Interest Rates
Since the economic crisis erupted in 2008, the Fed has maintained its benchmark short-term interest rate near zero.
Based on today’s Fed statement the Fed’s benchmark won’t be changing any time soon until the unemployment rate lowers and inflation becomes “well-anchored” in the market.
“In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored” the Fed statement states.
The Fed lowered its forecast for 2013 economic growth from a range of 2.0 percent to 2.3 percent compared to June’s earlier forecast of 2.3 percent to 2.6 percent.
Scott Minerd, Global Chief Investment Officer from Guggenheim Partners said yesterday on Bloomberg’s Street Smart that more quantitative easing is not just good for equity investors, it’s even better for bond investors.
“The Fed didn’t act because it realizes that the forward data on economic activity doesn’t look so good, especially given the weakness in housing” Minerd said. And because of that we are going to see a lot of downward pressure on rates” he added.
Yesterday the latest economic data for housing starts and building permits came in weaker than expected, missing estimates.