Federal Reserve Chairman Ben S. Bernanke is putting investors on notice that the central bank is prepared to begin phasing out one of the most aggressive easing programs in its century-long history later this year.
The Fed will probably taper its $85 billion in monthly bond buying later in 2013 and halt purchases around mid-2014 as long as the world’s largest economy performs in line with Fed projections, Bernanke told reporters yesterday in Washington after a two-day meeting of the Federal Open Market Committee.
“The vast, highly unprecedented, highly accommodative monetary policy stance that’s been so supportive of the recovery has begun to turn,” said Michael Gapen, senior U.S. economist for Barclays Plc in New York and a former economist in the Fed’s Division of Monetary Affairs. “The markets for the next several years or more will have to deal with the withdrawal of that support.”
Stocks and Treasuries tumbled at the prospect of a wind-down in bond buying that’s swollen the Fed balance sheet to a record $3.41 trillion in an attack against the worst joblessness since the Great Depression. While citing waning risks to the economy, Bernanke said curbs to bond buying hinge on gains in the labor market and a pickup in growth.
The yield on the benchmark 10-year Treasury note rose 3 basis points, or 0.03 percentage point, to 2.39% at 10:11 a.m. New York time after earlier climbing as high as 2.47%, the highest since August 2011. The yield jumped 17 basis points yesterday, the most since October 2011.
Bonds across the Asia-Pacific region fell, with Japan’s 10-year yield climbing 4 basis points to 0.86%. The yield on 10-year German bunds rose 9 basis points to 1.65%. The MSCI Asia Pacific Index of shares slumped 3.9% and the Stoxx Europe 600 Index slid 2.6%. The Standard & Poor’s 500 Index fell 1.4%. Gold fell below $1,300 an ounce to the lowest in since September 2010.
The conclusion to record stimulus may take years to complete as the Fed’s forecasts showed most officials don’t expect to begin raising the benchmark lending rate out of its lowest-ever range of zero to 0.25% until 2015. Bernanke, 59, whose second term as chairman ends on Jan. 31, warned investors against viewing the policy makers’ plans as inflexible, saying their decisions are not “deterministic.”
“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,” Bernanke said, referring to the FOMC’s outlook for “moderate” economic growth, further labor-market gains and inflation accelerating toward the Fed’s 2% goal.
If such gains are maintained, “we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year,” he said. A “strong majority” on the FOMC now expects it won’t sell mortgage-backed securities as part of their exit strategy.
The chairman’s description of the end of quantitative easing indicates that Fed officials see the economy finally healing from a burst credit bubble that deflated housing prices by 35% over almost six years, left one in 10 American workers unemployed in October 2009 and prompted the biggest overhaul of financial regulation since the 1930s.
The U.S. central bank began its third round of large-scale asset purchases in September by buying $40 billion a month of mortgage-backed securities. The Fed added $45 billion of Treasury purchases in December. The FOMC has said since September that it will buy bonds until seeing signs of substantial labor-market improvement.
The FOMC’s forecasts show the economy needs to cross some hurdles before meeting the criteria for a slowing of bond purchases. Officials expect the economy to grow 3% to 3.5% next year, driving the unemployment rate down to 6.5% to 6.8% from 7.6% in May, according to their central tendency estimates, which exclude the three highest and three lowest.
Economists in a Bloomberg survey are less optimistic. They estimate the economy will grow 1.9% in 2013 and 2.7% in 2014, according to the median estimates.
Bernanke said he was “deputized” by policy makers to deliver the message for reduced bond buying rather than rely on a “terse” written statement.
The committee in a statement yesterday made no changes to its current pace of monthly purchases. St. Louis Fed President James Bullard dissented, saying the committee should “signal more strongly its willingness to defend its inflation goal in light of recent low inflation readings.”
The Fed chairman’s message was a “blockbuster,” said Stephen Oliner, a member of the Fed’s forecasting division from 1984 until 2011.
“He was very aware that he has an extremely difficult communication job ahead of him because there are so many moving parts to monetary policy,” said Oliner, resident scholar at the American Enterprise Institute in Washington, a non-profit group that advocates free markets.
Policy makers “are going to really try to be sure that the market is pretty well aligned with their thinking every time they communicate,” he said.
Reducing stimulus and winding down the balance sheet without roiling markets is one of the biggest challenges Bernanke’s successor would face, should the chairman not serve a third, four-year term. President Barack Obama said this week that Bernanke has stayed in his post “longer than he wanted,” one of his clearest signals yet the Fed chief will leave.
Speculation the Fed will reduce purchases has lifted mortgage rates and government bond yields since May 22, when Bernanke told U.S. lawmakers the FOMC “could” reduce buying within “the next few meetings” if policy makers see evidence of labor-market gains that can be sustained.
Mortgage rates have posted six straight weekly gains that pushed home borrowing costs up 19% for the biggest increase in a decade. The interest rate on a 30-year fixed home loan climbed to a 14-month high of 3.98% last week, according to data compiled by Freddie Mac. The yield on the 10- year Treasury has jumped from a record low 1.38% in July.
Bernanke said Treasury yields have climbed in part because of optimism about the economy, and higher borrowing costs are offset by conditions such as increasing house prices. The S&P/Case Shiller index of property values in 20 cities rose 10.9% in March for the biggest annual gain since 2006.
“One important difference now is that people are more optimistic about housing” and expect prices to continue rising, he said. That gain “compensates to some extent for a slightly higher mortgage rate.”