June 21, 2013, 1:01 PM ET
Analysis: Markets Might Be Misreading Fed’s Messages
ByJon Hilsenrath
The markets might be misreading the Federal Reserve’s messages..
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In the two days since Fed Chairman Ben Bernanke said the central bank expects to curb its big bond-buying program later this year, stocks tumbled, long-term interest rates rose and interest-rate futures contracts fell, meaning investors bet the Fed would raise short-term interest rates sooner than previously expected.
“The FOMC was more hawkish than we had expected,” economists at Goldman Sachs concluded after the Wednesday Fed policy meeting, a view widely held on Wall Street trading floors.
However, a close look at Mr. Bernanke’s press conference comments and Fed official’s interest-rate projections released after the meeting show the Fed took several steps aimed at sending the opposite signal.
–Mr. Bernanke emphasized that even though the Fed might pull back on bond-buying later this year — which is akin to easing your foot off the gas pedal of a car — it would be a long time before it took the more aggressive step of raising short-term interest rates — which is akin to pressing the brake. He also emphasized in his prepared statement that when rate increases come, they “are likely to be gradual,” a hint of future caution about rate increases he hasn’t given before.
–Mr. Bernanke suggested the Fed could keep short-term interest rates near zero even longer than previously planned. Since December, the Fed has said it would keep short-term rates near zero at least as long as the jobless rate is above 6.5%. In his prepared statement, Mr. Bernanke emphasized that rates could stay low for a while even after unemployment falls below 6.5%, particularly if inflation stays low. “The more subdued the outlook for inflation,” he said, “the more patient the [Fed] would likely be,” he said. In the question-and-answer session he went even further and said for the first time that the Fed might even lower that 6.5% threshold.
–Fifteen Fed officials expect the central bank won’t need to raise short-term interest rates until 2015 or 2016 and just four said it would need to do so before then. That was a slight move away from early tightening: Previously five anticipated tightening before 2015. The average short-term benchmark rate expected at the end of 2015 among Fed officials didn’t change much – it was 1.34%, compared to 1.30% in March. The median expected rate – meaning half saw one higher and half saw one lower – remained unchanged at 1%.
–Mr. Bernanke said “a strong majority” of Fed officials had concluded the Fed won’t ever sell its growing portfolio of mortgage-backed securities, and instead will let it shrink as mortgages are paid off. In the past the Fed had said it might someday sell these bonds, a threat to any investor who held the bonds. He was more emphatic than ever Wednesday about not selling.
–A hawk became a very vocal dove. St. Louis Fed president James Bullard dissented from the Fed’s policy statement, saying he thought the central bank should be leaning toward even easier money policies. In the past, Mr. Bullard has tended to side with Fed “hawks” opposed to easy money policies. In a statement his office released Friday morning, he argued that the Fed’s decision to lay out a plan for pulling back easy money was “inappropriately timed” because inflation and economic output have been soft.
–Mr. Bernanke emphasized the conditional nature of the Fed’s plan to withdraw bond-buying. “If you draw the conclusion that I’ve said that our policies, that our purchases, will end in the middle of next year, you’ve drawn the wrong conclusion, because our purchases are tied to what happens in the economy … we have no deterministic
or fixed plan.”
“People have come to expect that the Fed is going to err on the side of being more growth friendly,” said Michael Feroli, a J.P. Morgan economist. Investors wanted to hear “that he would see the job through and not take the punch bowl away until [the economy is] really getting going.”
In Eurodollar futures markets, expected three-month borrowing rates in December 2014 jumped from 0.55% to 0.76%. The expected federal funds rate in December 2014 rose from 0.28% to 0.385%.
These movements imply investors see increasing odds of Fed rate increases by the end of 2014.
On Friday markets started to settle, with stocks opening moderately higher.
The market reaction underscores the challenge the Fed has created for itself by launching the bond-buying program and other unconventional efforts to boost economic growth. At some point it will have to exit from those programs and communicate clearly about how and when that will happen. Officials hope to accomplish both tasks without creating the kind of market turmoil that could set back the recovery they’ve tried to energize. This week’s events show how hard that will be.
The only statement from a Fed official since the meeting has come from Mr. Bullard .
Mr. Bullard was clearly worried about how the market would respond to the Fed’s decision to announce a timetable for winding down its bond buying. He “felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement,” according to his statement.
Given the market turmoil that has since ensued, other Fed officials might now be wondering if he was right.
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