The FOMC statement and economic forecasts showed only few changes, but the undertone of the statement and press conference was optimistic on growth. Too low inflation is getting more attention, but less than growth optimism. The asset purchase programme remains unchanged, but there were multiple hints that the Fed may soon start to gradually reduce the pace of asset purchases. If the economy evolves according to the economic projections, purchases may end by mid 2014, when unemployment should have fallen to 7%. To soften the blow of this intention to reduce purchases, Bernanke tried hard to minimise the impact of reducing purchases on yields and the economy and stressed many times that future decisions on the subject all depend on the development of the economy, labour market and inflation. The FOMC, Bernanke said, was ready to slow the pace of tapering, to stop it or even increase bond buying when the economy didn’t evolve as expected. In the same vein, he repeated that rates would remain at current exceptional low levels as long as the employment rate remained above 6.5%. He added that even when the threshold is reached, the policy rates may remain unchanged. He suggested that eventually the FOMC might lower the unemployment rate threshold, but excluded an increase. Similarly, if inflation would be too low, it might affect decisions on the timing of tapering of asset purchases and of rate increases. Similarly, while discussions on the exit policy have not been finished, he said that during the normalization of policy, the Fed would not sell MBS-related assets from its portfolio.
Despite all Bernanke’s efforts to downplay the importance of the (likely) reduction of asset purchases, the market was apparently still surprised and spooked by the timing and prospect of reducing asset purchases. It seemed as if market reasoned that the inflection point of the super loose monetary policy was inevitably moving closer and Bernanke’s words to downplay its importance were an understandable attempt of the central bank to keep the necessary market repositioning gradual and FOMC more optimistic on growth and employment, but slightly more concerned on inflation.
Tapering purchases to start later this year and maybe finished mid 2014 Start, pace and end tapering remain very much data dependant.
Bernanke tries to convince markets that start of the rate cycle is still far away and independent on the fate of the asset purchase programme. First reaction of markets suggests Bernanke didn’t succeed in calming markets. Fed prepares for tapering asset purchases orderly. As a consequence, equities lost about 1;4%, while bonds were heavily hit, especially in the belly of the curve where yields rose by 16 to 20 basis points. The 10-year yield set new highs and broke above the top of its upward sloping channel, suggesting that the key 2.40% resistance may soon be tested. However also the Dec 2014 3m Eurodollar contract (99.33) fell substantially, again discounting a decent chance for a first rate hike by the end of 2014/early 2015. This suggests that Bernanke’s attempt to convince markets that tapering asset purchases would not impact the decision to raise rates failed (earlier raised by Hilsenrath in the WSJ and likely suggested by some Fed sources). The overwhelming majority of Fed governors (14 out of 19) put the first rate hike in 2015 (even mid 2015 most likely given rate expectation for end 2015). The dollar gained against both the euro and the yen, but contrary to the yields, the technical pictures of the dollar and of the S&P were not significantly affected. The market reaction suggests Bernanke and fellow governors will have a hell of a job managing expectations, especially if eco data would strengthen. When will they start their campaign?