Long Live The Bernanke Put: FOMC Tapers QE As Fed Balance Sheet Nears $4 ...
ASCII Bernanke (Photo credit: Travis Goodspeed)Fed Chairman Ben Bernanke seems to have gotten back his touch. After having lost control of the market earlier this year indicating the FOMC could decide to taper quantitative easing before the end of the year, on Wednesday the Chairman managed to spark a big rally on Wall Street while reducing the level of monetary accommodation.
Regardless, while Bernanke managed to begin the process of exiting an ultra-accommodative monetary stance before passing the reins to Janet Yellen, the FOMC went to great lengths to make it clear it remains in full support of the market, pledging to keep rates low 'well past the time that the unemployment rate declines below 6-1/2 percent [threshold],' and promising the more QE could be in the cards. As the market roars on betting on the Bernanke put, Yellen may still be stuck between a rock and a hard place as she is tasked with normalizing monetary policy.
Bernanke finally did it. After warning investors early in 2013, the outgoing Fed Chairman initiated the feared taper, cutting its asset purchases by $10 billion a month starting January. After months of market turmoil, followed by an unprecedented run into record territory, investors were finally prepared to stomach a $10 billion reduction in the pace of asset purchases without freaking out. After an initial slip, the Dow went on a triple digit rally while shares in major banks including JPMorgan Chase, Citigroup, and Bank of America jumped. Gold prices swung violently but were trending higher, while the yield on 10-year Treasuries moved up to 2.9%.
Is this a victory for Bernanke? To a certain extent, yes. The Chairman's words earlier this year, first disclosing the intention to taper in Congressional testimony, led to an aggressive tightening of financial conditions that hurt interest rate sensitive sectors of the economy, particularly by pushing mortgage rates dramatically higher. Even in the face of a more reluctant FOMC, markets freaked out.
The decision not to taper on September had the opposite reaction, unleashing the bulls who helped push the stock market to record highs once again. With the Fed concerned that QE was becoming marginally less effective, and possibly toxic in that it could fuel asset bubbles, managing to taper without spooking the market is a win for Bernanke & Co.
The problem is that they did so at the extent of continuing to feed investors' addiction for easy money. The Federal Reserve is still growing its balance sheet at an impressive rate, $75 billion a month, and it has now promised to keep interest rates lower for longer. With Janet Yellen at the helm, the FOMC will face the monumental challenge of unwinding a balance sheet that will soon top $4 trillion. Yellen & Co. will have to figure out a way of telling investors the party is beginning to come to an end without causing a knee-jerk reaction that could push panicking investors to push interest rates dramatically higher, leaving the Fed out of the game.
All the way to the end of the Chairman's tenure, the Bernanke put continues to deliver. It will be up to Yellen, then, to lead the next market cycle.
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