Ben Bernanke has just concluded a speech in the US where he has tried to talk down long bond rates by implying that markets have over reacted to Fed tapering. I’ve extracted the apposite paragraphs. the full speech is here.
The public’s expectations about future monetary policy actions matter today because those expectations have important effects on current financial conditions, which in turn affect output, employment, and inflation over time. For example, because investors can choose freely between holding a longer-term security or rolling over a sequence of short-term securities, longer-term interest rates today are closely linked to market participants’ expectations of how short-term rates will evolve. If monetary policymakers are expected to keep short-term interest rates low, then current longer-term interest rates are likely to be low as well, all else being equal. In short, for monetary policy, expectations matter.
…As my colleagues and I have frequently emphasized, the conditions stated in this guidance are thresholds, not triggers. Crossing one of the thresholds will not automatically give rise to an increase in the federal funds rate target; instead, it will signal only that it is appropriate for the Committee to begin considering whether an increase in the target is warranted. This threshold formulation helps explain why the Committee was willing to express the guidance bearing on the labor market in terms of the unemployment rate alone, instead of following its usual practice of considering a broad range of labor market indicators. In the judgment of the Committee, the unemployment rate–which, despite some drawbacks in this regard, is probably the best single summary indicator of the state of the labor market–is sufficient for defining the threshold given by the guidance. However, after the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation. In particular, even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.
…Financial market movements are often difficult to account for, even after the fact, but three main reasons seem to explain the rise in interest rates over the summer. First, improvements in the economic outlook warranted somewhat higher yields–a natural and healthy development. Second, some of the rise in rates reportedly reflected an unwinding of levered positions–positions that appear to have been premised on an essentially indefinite continuation of asset purchases–together with some knock-on liquidations of other positions in response to investor losses and the rise in volatility. Although it brought with it some tightening of financial conditions, this unwinding and the associated rise in term premiums may have had the benefit of reducing future risks to financial stability and, in particular, of lowering the probability of an even sharper market correction at some later point. Third, market participants may have taken the communication in June as indicating a general lessening of the Committee’s commitment to maintain a highly accommodative stance of policy in pursuit of its objectives. In particular, it appeared that the FOMC’s forward guidance for the federal funds rate had become less effective after June, with market participants pulling forward the time at which they expected the Committee to start raising rates, in a manner inconsistent with the guidance.
To the extent that this third factor–a perceived reduction in the Fed’s commitment to meeting its objectives–contributed to the increase in yields, it was neither welcome nor warranted, in the judgment of the FOMC. This change in expectations did not correspond to any actual lessening in the FOMC’s commitment or intention to provide the high degree of monetary accommodation needed to meet its objectives, as Committee participants emphasized in subsequent communications.
All very prim, proper and wrong. Andy Haldane of the BoE put it much better:
“Let’s be clear. We’ve intentionally blown the biggest government bond bubble in history…We need to be vigilant to the consequences of that bubble deflating more quickly than [we] might otherwise have wanted…The “biggest risk to global financial stability… would be a disorderly reversion in the yields of government bonds globally.”
That is why Ben can’t undo his stimulus slowly. The moment he does the exit is jammed with folks looking to dodge risk, just as they’ve ignored it for years at our Ben’s bidding.
I see no reason to think that any of this “communication” will prevent long bond rates going straight back to 4.5% (up 1%) if the Fed tapers. That’s where they’ve been whenever it did so before. Thus choking off the US recovery.
