The Taper Chase

CAMBRIDGE – Global financial markets were stunned when the US Federal Reserve announced on September 18 that it was not ready to begin the widely anticipated reduction in the pace of its “quantitative easing” (QE) program. Fed Chairman Ben Bernanke said that the Fed would continue its monthly purchases of $85 billion of long-term securities. Understanding the reasons for the Fed’s unexpected change of plans may help to anticipate what is coming next.

After Bernanke announced in May that the Fed intended to “taper” QE, investors began to expect that some reduction in the pace of asset purchases might begin in the early fall. As a result, the interest rate on ten-year Treasury bonds increased by nearly 50 basis points, from 1.66% on May 1 to 2.13% on at the beginning of June. Bernanke’s press conference after the next meeting of the Federal Open Market Committee (FOMC) on June 19 caused a further rise in the ten-year rate, to 2.5% on July 1 and then to 2.92% just before the Fed’s September meeting.

In short, the market was clearly expecting that the tapering would begin in September and that the asset-buying would end in mid-2014. There are at least three possible reasons why the Fed shifted its actions and policy guidance so dramatically.

One possibility is that Bernanke and the other FOMC leaders – especially Vice Chair Janet Yellen and New York Fed President Bill Dudley – never intended to start tapering. Their earlier statements sought merely to reassure FOMC members who wanted to end QE that the leadership was listening to their arguments and taking them seriously. Doing that prevented QE’s opponents from voting against the majority FOMC position, something that would suggest policy disarray at the Fed and a lack of respect for Bernanke. If this explanation is correct, Fed leaders can be expected to continue with an undiminished program of buying long-term securities into next year.