In the four weeks since Ben Bernanke first mentioned that the Federal Reserve Board might start to taper its program of quantitative easing (QE) later this year, more than $2 trillion was wiped off the value of global stock markets — and probably far more from the value of global bonds, which is harder to estimate.
On Wednesday Bernanke spent almost an hour answering press questions to try to clarify the Fed’s policy on interest rates and QE. The result was a further steep fall in equity and bond prices around the world. Does this mean that Bernanke did not really want to signal to, and pacify, financial markets and was trying, instead, to prepare investors for higher interest rates and tougher times ahead? Or is it possible that the market has simply misunderstood his comments, both at Wednesday’s press conference and in his statement on May 22?
I have argued repeatedly in this column for the last interpretation — that tapering would not begin before the end of this year and that financial markets have misinterpreted the Fed’s intentions, partly for reasons connected with the vested interests of analysts and traders, whose livelihoods depend on convincing the world that economic policy is highly volatile and uncertain. If monetary policy were predictable and stable, which is essentially what Bernanke has promised, then the status and salaries of Fed-watchers in Washington would be hard to justify and the profits of short-term macroeconomic speculators would disappear. But maybe this view was simply wrong.
After all, equity and bond prices fell further and volatility intensified as investors absorbed Bernanke’s hour-long exposition of the Fed’s plans. Given that Bernanke has now laid out the conditions for a tightening of monetary policy with unprecedented transparency, precision and authority, investors may simply have concluded that the Fed really will start to taper its monetary stimulus in the near future, contrary to the arguments presented in this column and by many other commentators since May 22. Goldman Sachs, for example, put out a statement after Bernanke’s press conference frankly admitting that their earlier, more relaxed view of Fed policy was wrong and they had changed their minds: “We were expecting a dovish Fed and for Bernanke to calm markets, but got just the opposite…the Fed was more hawkish than expected… the risk to our forecast of QE tapering starting in December has increased.”
If tapering does start well before the end of the year, this will surely be bad news for financial markets and the world economy. After all, monetary policy is generally believed to be the major force powering global economic recovery and the doubling of stock markets since early 2009. Thus if the Fed really is going to withdraw monetary stimulus earlier than previously expected, it seems logical for both growth expectations and asset prices to fall — and this is exactly what has happened since May 22.