Bernanke Prepares for Final Press Conference: All Eyes on Fed

Federal Reserve

Source: http://www.flickr.com/photos/23165290@N00/

The eye of the market is on the U.S. Federal Reserve. Policymakers will conclude a two-day policy meeting on Wednesday, and the air is dense with speculation. Many market participants are expecting the Fed to announce a long-awaited change in monetary strategy, the most significant component of which would be a tapering of asset purchases. After the meeting, Ben Bernanke will hold his final press conference as chair of the Federal Reserve.

Many investors and market watchers have attributed the post-crisis market rally to the Fed’s highly accomodative monetary policy — and, specifically, to quantitative easing. Quantitative easing, or QE, is a program through which the Fed is purchasing $85 billion worth of agency mortgage-backed securities and longer-term Treasury securities every month.

The Fed began the current round of asset purchases in September 2012. These purchases increase the price of those financial assets, which lowers their yield, putting additional downward pressure on long-term interest rates. The intended consequence is to spur spending in interest rate-sensitive sectors, which, as Fed Vice Chair Janet Yellen articulated in her recent testimony before the Senate Banking Committee, should “stimulate a favorable dynamic in which jobs are created, incomes rise, more spending takes place.”

Broadly speaking, the strategy has been successful. The stock market has rallied in the post-crisis years, and corporations, flush with cheap credit, are using the money to repurchase shares at near record rates.

As soon as the the flow rate of stimulus is reduced, though, the music begins to die down, and the rally will lose steam. Market watchers witnessed two so-called taper tantrums already in 2013, when Bernanke simply suggested that a taper was on the table. Equity prices tripped over themselves and fell while interest rates spiked, foreshadowing what could happen should the Fed actually announce a policy change this afternoon.

However, speaking with Bloomberg on Tuesday, PIMCO Chief Executive Mohamed El-Erian suggested that the Fed wouldn’t simply announce a taper — it would announce a package of policy changes that begin to steer the central bank back to shore. This could mean a change in the mix or type of purchases (or a reduction), as well as changes to forward guidance. With the chair position expected to be passed on to Yellen in January, the Fed is beginning a new chapter. One, hopefully, that will put crisis-era policies behind it.

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