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Ben Bernanke: Fed’s Bond Purchases Aren’t on a Preset Course

JUL 17, 2013 1:44pm ET
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Federal Reserve chairman Ben Bernanke said the central bank’s asset purchases “are by no means on a preset course” as he sought to tamp down an increase in borrowing costs that threatens to slow the economic expansion.

“We’re going to be responding to the data,” Bernanke said today to the House Financial Services Committee. “If the data are stronger than we expect, we’ll move more quickly” to reduce purchases. If data “don’t meet the kinds of expectations we have about where the economy’s going, then we would delay that process or potentially increase purchases for a time.”

Stocks and Treasuries rallied on optimism that the Fed is prepared to delay an exit from its quantitative easing program should the four-year expansion show signs of faltering. Fed officials are trying to reverse an increase in Treasury yields since June 19, when Bernanke outlined the possible timing for a reduction in the $85 billion monthly pace of bond purchases.

“Clearly what happened in the markets after June was well beyond what they intended, and they’re trying to pull it back,” said Julia Coronado, chief economist for North America at BNP Paribas SA in New York and a former Fed board staff economist. “He has chosen to emphasize the conditionality of the baseline tapering forecast on data—and not just employment data but growth, inflation and importantly, financial conditions.”

The yield on the 10-year Treasury note fell to 2.48% at 12:30 p.m. in New York from 2.55% before the testimony. The Standard & Poor’s 500 Index rose 0.3% to 1,681.61.

The 10-year yield rose as high as 2.74% this month from 1.93% on May 21, the day before Bernanke said the FOMC may trim its bond buying in its “next few meetings” if officials see signs of sustained improvement in the labor market.

In prepared remarks, Bernanke said the Fed could keep buying bonds for longer if “financial conditions—which have tightened recently—were judged to be insufficiently accommodative to allow us to attain our mandated objectives.”

Responding to a question, he said the policy makers have succeeded in reducing market volatility that has greeted the Fed’s discussion of tapering.

“I think markets are beginning to understand our message, and the volatility has obviously moderated,” he said.

Policy makers have tried to assure investors that the Fed will hold down the benchmark interest rate after ending bond buying. Bernanke, in an appearance in Cambridge, Massachusetts, on July 11, said “highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy,” a message he repeated today.

The Fed chairman described labor markets as “far from satisfactory, as the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high.”

While risks to the economy have diminished since late last year, Bernanke said, the slow pace of the recovery means that it remains “vulnerable to unanticipated shocks, including the possibility that global economic growth may be slower than currently anticipated.”

In addition, “the risks remain that tight federal fiscal policy will restrain economic growth over the next few quarters by more than we currently expect, or that the debate concerning other fiscal policy issues, such as the status of the debt ceiling, will evolve in a way that could hamper the recovery.”

“This testimony is the relatively dovish Bernanke,” Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., said in an interview on Bloomberg Television’s “In the Loop” with Betty Liu. “The underlying economy is still quite fragile.”
Bernanke also discussed dangers posed by an inflation rate that has remained below the Fed’s 2% goal.

Some sources of declining inflation “are likely to be transitory” and expectations for future price increases “have generally remained stable,” he said in his prepared remarks. At the same time, “very low inflation poses risks to economic performance—for example, by raising the real cost of capital investment—and increases the risk of outright deflation.”

The FOMC said in a June 19 statement that keeping the federal funds rate between zero and 0.25% “will be appropriate at least as long” as unemployment remains above 6.5% and the forecast for inflation in one to two years doesn’t exceed 2.5%.

Fed officials estimate the 6.5% unemployment threshold could be reached by the end of next year. That outlook is based on estimated growth of 3% to 3.5% for the economy in 2014, according to the committee’s June central tendency estimates, which are higher than the 2.9% estimate of private forecasters in a Bloomberg survey.

After that meeting, Bernanke said the FOMC may begin tapering bond purchases “later this year” and halt the program around mid-2014 if the economy performs in line with the Fed’s forecasts.

The chairman again took pains today to explain that the unemployment rate isn’t the only measure of labor market health.

“For example, if a substantial part of the reductions in measured unemployment were judged to reflect cyclical declines in labor force participation rather than gains in employment, the committee would be unlikely to view a decline in unemployment to 6.5% as a sufficient reason to raise its target for the federal funds rate,” he said. Increases in the benchmark lending rate “are likely to be gradual” when they happen, he said.

Bernanke, seeking to help unemployed Americans find work, has orchestrated the most aggressive easing in the central bank’s 100-year history, expanding its balance sheet to $3.5 trillion from $869 billion since August 2007 and keeping the main interest rate close to zero since December 2008.

Today, Bernanke claimed credit for fueling a rebound in sales of autos and homes, two industries that are driving the economic expansion. Fed asset purchases have also helped propel this year’s 17.5% surge in the S&P 500 Index of stocks.

The job market has shown signs of recovery. Non-farm payrolls have expanded on average by around 200,000 jobs per month from January through June. The proportion of unemployed workers who have been without a job for six months or more has fallen to less than 37% from about 40% when Bernanke launched the third round of quantitative easing in September.

Highlighting risks to the expansion, a Commerce Department report today showed housing starts unexpectedly fell in June to the lowest level in almost a year.

“Housing activity and prices seem likely to continue to recover, notwithstanding the recent increases in mortgage rates, but it will be important to monitor developments in this sector carefully,” Bernanke said.

The average 30-year fixed-rate mortgage has risen to 4.51% as of July 11 from 3.51% two months ago, according to Freddie Mac.

Consumer spending also remains vulnerable. Retail sales climbed 0.4% last month, about half of what economists forecast, and the figures showed households are replacing outdated vehicles and furnishing new homes while cutting back on electronics and meals outside the home.

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