Federal Reserve Chairman Ben S. Bernanke says the end of the central bank’s bond buying won’t constitute a move toward tighter policy. He may have a tough time convincing stock and bond investors that’s true.
The Fed is acquiring $85 billion of securities each month, and policy makers are grappling with how to condition markets not to interpret a stop in those purchases as a prelude to the exit from easy credit. Bernanke said Dec. 12 in Washington that he “would emphasize” the end won’t be “a turn to tighter policy.”
If the Fed fails, interest rates may climb prematurely, as traders arrange positions for the withdrawal of unprecedented monetary stimulus, according to Dean Maki, chief U.S. economist at Barclays Plc in New York. The Fed has kept its benchmark federal funds rate near zero for more than four years and swelled its balance sheet to a record of more than $3 trillion through three asset-purchase programs.
“There is a risk the markets get ahead of the Fed,” said Maki, a former Fed board economist. “It will be tricky for the Fed to signal it’s going to stop buying without signaling that tightening is imminent.”
Ending the Fed’s third round of so-called quantitative easing carries greater significance than completion of the previous two because those were introduced with defined amounts and durations.
For QE3, the Federal Open Market Committee in September announced purchases of $40 billion a month in mortgage-backed securities, leaving the program open-ended until the labor market improves “substantially.” In December, the FOMC added $45 billion of monthly Treasury purchases.
Marilyn Cohen, founder of Envision Capital Management Inc. in Los Angeles, said she doesn’t think the Fed will be able to convince traders that interest rates aren’t going up when the central bank stops buying bonds. Cohen said she’s already lowered the interest-rate sensitivity of her $325 million portfolio in preparation.
“The markets are on edge; and any hint that things are changing, and we will see the repercussions,” Cohen said. “I’ve been in this business since 1979 -- I’m one of the old dinosaurs -- and I cannot remember when there was such a chorus in the investment landscape that all are calling for higher rates.”
Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co.; Jim Rogers, chairman of Rogers Holdings; Wells Capital Management Inc. and Goldman Sachs Group Inc. all have voiced concern about long-term bonds.
The Jan. 3 release of the minutes from the FOMC’s Dec. 11-12 meeting illustrates investors’ sensitivity, Cohen said. Central bankers discussed possibly curtailing or halting their asset purchases this year. That surprised analysts and traders, sending the Standard & Poor’s 500 Index down 0.2 percent and pushing up yields on the benchmark 10-year Treasury note 0.07 percentage point that day.
James Bullard, president of the Federal Reserve Bank of St. Louis, says the “communication challenge” the central bank faces with the end of QE3 is comparable to all periods of easing.
“The same thing happens with interest-rate policy; you’re lowering the interest rate, and after a while you decide to quit lowering the interest rate and just hold it steady,” Bullard said in a Feb. 1 interview in Washington. “And at that point, you have to convince markets this is really a lower rate than it used to be.”