At least part of the reason for Tuesday’s dance to the downside was the fear that Ben Bernanke would lob a “tape bomb” toward Wall Street during his testimony in front of the House Financial Services Committee. While no one in their right mind thought that Mr. Bernanke would start talking about raising rates anytime soon, the fact that the Fed pulled a sneak attack with the increase in the Discount Rate last Thursday left traders wondering if there were any more surprises coming soon.
But instead of issuing surprises, Bernanke basically stuck to the script in front of the Financial Services Committee Wednesday. And most importantly, Bernanke used the now famous words, “for an extended period” when describing his outlook on how long it might be before interest rates need to start going up.
Although the Fed did seem to go out of their way to let investors know that last week’s hike in the Discount Rate had nothing to do with monetary policy, the worry was that the FOMC had suddenly and without warning, changed their tune. So, the phrase “for an extended period” was music to the ears of traders on Wednesday.
The Fed Chairman told Congress that a weak job market and tame inflation will allow the Fed to keep rates low for some time yet. In what can be described as a somber assessment of the economy, Bernanke said that,"Notwithstanding the positive signs, the job market remains quite weak."
Bernanke acknowledged that while job losses were abating, the overall environment remains tough and that the Fed stands ready to support the economy. “The FOMC continues to anticipate that economic conditions—including low rates of resource utilization, subdued inflation trends, and stable inflation expectations—are likely to warrant exceptionally low levels of the federal funds rate for an extended period," he said.
However, the Fed Chairman also said that the FOMC would need to return rates to more normal levels at some point. On that score, Fed officials have opined recently that the FOMC would likely wait at least several months before removing the all important “extended period” phrase from their policy statement. In short, the removal of this verbiage will likely act as a signal to the markets that the Fed Funds rate is about to begin rising.
We have two takeaways from Bernanke’s testimony. First, given the market reaction, we will suggest that the worry that the Fed might be changing its tune was more important than any of the recent economic data. Everybody knows the economic recovery will be uneven. Thus, some bad economic news here and there shouldn’t surprise anyone. However, a change in the Fed’s well-telegraphed course would have been a game changer.
The second big thing to take away from Wednesday’s testimony is that the Fed’s exit strategy will be cautious, choreographed, and well communicated. And although the timing of some of the Fed’s moves remains uncertain, Bernanke & Co. appear to be going out of their way to make sure everyone understands what they are going to do before they do it.
In sum, the testimony confirmed that Bernanke is still running a very transparent Fed and that he has no interest in surprising the markets. Thus, for now at least, we should continue to take Bernanke and the Fed at their word and listen for clues as what they will do next and when.
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