Are markets making another blunder?

June 20, 2013

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.

There are, however, two other possible interpretations of this week’s Fed press conference. One is that analysts and investors who misread Bernanke’s comments on May 22 have done it again this week. The other is that even if the Fed does start to withdraw monetary stimulus before December, this will not prove as traumatic as many investors now seem to believe.

These two issues are closely related. Bernanke was very specific on Wednesday about several key points: he virtually guaranteed that short-term interest rates would remain zero until 2015, regardless of economic conditions; he emphasized that 6.5 percent unemployment was not a target or “trigger” for higher interest rates, but merely a “threshold” before which rate hikes would not even be considered; he added that the Fed’s objective was to reduce unemployment to well below 6.5 percent and that monetary stimulus would continue even after this threshold was reached, provided inflation remained below 2.5 percent; and he stated repeatedly that there would be no timetables for reducing the QE program and that tapering would only be considered this year if the Fed’s employment and growth forecast objectives were clearly being achieved.

Combining all these promises points to a clear implication. The Fed will only consider reductions in monetary stimulus if employment and economic activity are growing strongly, in line with its latest forecasts, and if there are good reasons for confidence that these positive trends will be maintained. Given that the Fed forecasts published this week were substantially stronger than the expectations of most market economists, the conclusion that logically follows is that tapering will only happen if the U.S. economy does substantially better than investors currently expect. In other words, either the economy will surprise on the upside or the Fed stimulus will continue at full steam. The one contingency that Bernanke explicitly and repeatedly excluded was that U.S. employment growth would weaken and monetary stimulus would simultaneously be reduced. Yet this is precisely the outcome that many investors and analysts now seem to expect.

Is it really possible that markets have simply misinterpreted something as important as Bernanke’s comments on May 22 and are continuing to do so, despite this week’s clarification? Such a suggestion may seem preposterous to believers in the omniscience of efficient markets, but financial markets have made plenty of spectacular mistakes in the past. The blunders in the ten years to 2008 were mostly on the side of over-optimism — the bubbles in U.S. mortgage bonds, housing and before that internet stocks. Since 2009, however, financial mistakes have mostly been in the opposite direction — refusal to acknowledge the powerful bull market that started in April 2009, exaggerated expectations of a euro breakup, and most recently the unwarranted market panic over U.S. budget deficits and the “fiscal cliff.” The instant reaction to Wednesday’s comments by Bernanke looks like the latest example of such a bearish blunder.

PHOTO: U.S.Federal Reserve Chairman Ben Bernanke speaks to the press following the Fed’s two-day policy meeting at the Federal Reserve in Washington, June 19, 2013. REUTERS/Jason Reed


We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see

Kaletsky: Just another “genius” who thinks he’s smarter than “the markets”.

Posted by unionwv | Report as abusive

All the way through your post you state “investor”.

Huge problem for you, the vast majority of they money in this disconnected bubble is “speculators” with margin trading accounts, not term investors.

American companies and investors are sitting on the largest percentage of CASH on record.

Hence the news driven twitchy market as most of the money is hft and speculators, they don’t care which way it moves as long as it does and they are on the correct side off it or hedged safe.

I would love to be able to get the true market picture IE with all the hedged/covered positions removed.

This is very hard to do since many of the anti hedging regulations in various countries resulted in nothing except traders with multiple accounts.

Posted by nzl-kz7 | Report as abusive

Idea that markets can “blunder” is shibboleth. Markets are liquidity meters. They can’t make mistakes. They reflect what is. Pundits make blunders. Misinterpreting the facts is their stock in trade.

Markets tell us what the price is. They don’t think. They don’t discount the future. Prices reflect the ebb and flow of systemic liquidity.

Chart- yzy.png

Posted by LeeAdler | Report as abusive

Yes, Markets Never Blunder… keep repeating that while looking back over the dot-com bust …. where do you goofs come from?

Posted by Benny27 | Report as abusive

From a Dec 2012:

“When you talk about 2013 as another 1989 I guess you are still bearish economically? Do you disagree with the technocrats Ben Bernanke & Mario Draghi, the politicians Wolfgang Schäuble & Angela Merkel & François Hollande, the journalists Anatole Kaletsky & Roger Bootle & Jeremy Wagner and many others who call themselves cautiously optimistic and say we have passed the worst?” (28 Dec 2012, D.T., New York, Trader Financial Markets)

Yes of course I am still ultra bearish. The whole point of this web site and this article is that we are in the midst of a massive paradigm change, not just economically but also ethically and intellectually and spiritually. Think about the line above: “paradigm change is very sticky because even when a new insight is right, even dazzlingly right in hindsight, vested interests and other forms of inertia resist its adoption”. Where are we today? I think we are just about at the stage where is getting to be dazzlingly obvious to a lot of people including the author of that line, namely Niall Ferguson, that we are currently stuck on the wrong side of history during a paradigm change event. But how many steps have we taken toward the new era? So far, none. What does that mean? It means the disease is still raging, the ship is still sinking, the economic pain doesn’t stop until we wake up and change our lives. Why are all these people you mention cautiously optimistic etc? For the same reason that Steve Ballmer is cautiously optimistic of Windows 8 sales. Because their reality is being twisted upside down by their ego, on the trading floor we would say they are “talking their own book”.

It should be obvious to you, a trader in financial markets, that all these optimistic people have effectively lost the plot. You see you don’t even have to believe in paradigm change to be bearish. For example, back in 2008 I remember Niall Ferguson giving a radio interview arguing with the other panellists saying the long term outlook is appalling, we have WW2 style debt loads in the public sector, 1930s private sector debts, 1920s inequality, unaffordable heath and pension systems, declining education, gridlocked political systems, rapidly worsening environmental conditions and much smarter international competitors such as China. Ask yourself which of these factors lessened in the last five years of crisis? None right, they are all worse. EU politicians claim they have turned the corner on reforms but it’s all just talk. Look at Spain, in 2012 they have run an 8% deficit and unemployment is at 25% and the country is splitting apart. The USA is no better, the political system is totally dysfunctional and debt is piling up and the fundamental situation is far worse than it was five years ago. Therefore even a one eyed man who cannot see past the surface, in other words a man who cannot see the paradigm change taking place, can still see with his other eye that on the current path the next five years are going to be vastly worse than the last five years because we are still stuck in a well with no light around us!

Posted by | Report as abusive