Fed tapers, now the hard part begins

Ben Bernanke

It was one of the most anticipated moves in monetary policy.

Yet the Fed trimming its monetary stimulus - cutting its cash injections by $10bn to now inject $75bn per month - still managed to surprise.

Despite the timing surprise, US stocks - the Dow and S&P 500 - closed at record highs on the so-called "taper" finally happening.

But the hard part begins now.

The cutback is of US Treasury purchases from $45bn to $40bn per month and mortgage-backed securities (MBS) from $40bn to $35bn.

The evidence suggests that MBS has been more effective at lowering mortgage costs by increasing liquidity in the housing market than buying US government bonds has been in lowering long-term interest rates. In any case, both are being cutback from the start of next year.

Looking to the future

It was Bernanke's last press conference even though he steps down at the end of January since next month's FOMC doesn't have one.

Announcing the decision to taper starting in January 2014 while at the same time setting out interest rate expectations seemed to have worked as stocks were cheered in the U.S. That's also likely due to better economic signs.

After all, Congress has seemingly managed to overcome a fiscal impasse that could have seen a repeat of the government shutdown and debt ceiling debacle early next year.

Plus, crucially, nearly 200,000 jobs per month have been added on average in the past three months. But, even at that rate, it will take years for employment to fully recover.

Happy traders on NYSE US stock markets reacted well to the Fed's decision to cut back on stimulus
Crucial communications

Thus, the importance of the press conference to set out the "separation principle" between cash injections or quantitative easing (QE) and interest rates.

For many, of course, the quantity and price of money are closely related. It's just that in the jargon, we are at ZIRP (zero interest-rate policy).

It's one of the extraordinary things about all of this cheap cash - how low inflation is despite the Fed injecting $4 trillion (yes, that's nearly double the size of the entire UK economy whose GDP in dollar terms is around $2.5 trillion).

Using the Fed's preferred measure of inflation, prices are rising by just 0.7%. This is considerably below their 2% target and in spite of the Fed balance sheet at about a quarter the size of the entire US economy, which is the largest in the world.

This is why Mr Bernanke and other central banks such as the Bank of England espouse "forward guidance", so that QE is viewed separately from interest rate rises.

Once the cash injections end for the Fed, like they have in the UK, then their forward guidance maintains that rates will remain low for a long period of time until the economy recovers. The big question here is whether they will be believed by markets who determine the rate at which they will lend to the government over the longer term.

After all, there are those who have little faith in ZIRP and anticipate the inflation will take off. If so, then they are unlikely to lend money at a low nominal interest rate since their real return is the difference between the nominal rate and inflation down the line.

This will be the hard part - to convince markets to keep rates low in accordance with the central bank's base rate.

It is, after all, the markets that determine the borrowing costs for not just governments, but for all of us. This is particularly the case since the US wholesale money market is an important part of funding banks alongside deposits. So, if funding costs start to rise in the US, then Europe and other advanced economies will feel the impact.

Market in India with man holding herbs The Fed's decision will have an impact on overseas economies like India's
Overseas impact

There are also implications for emerging economies.

Money has left these economies since Mr Bernanke first mentioned tapering back in May, which I have written about before.

The cost of money certainly matters for these economies, some of which have become indebted to cheap foreign money. For the first time since the financial crisis, more emerging economies have been downgraded than promoted by the rating company Fitch last year, for instance.

For all of us, the big question is when will rates rise and get back to normal.

I recently spoke to Richard Koo of Nomura who has written about Japan's debt trauma and how a generation of Americans wouldn't borrow after the Great Depression because they were so relieved to be freed from debt. Interest rates stayed at ZIRP for over 20 years.

Times are different now, though five years from the crash, the Fed is still printing cash to the tune of $75bn per month. There is likely still some way to go before things go back to normal.

Finally, on the timing of taper, one of Mr Bernanke's answers was perhaps telling.

He listed forward guidance alongside asset purchases (cheap cash injections) alongside his crisis management as his legacy. His swansong before leaving office was to set in train "taper" and the most demanding test for forward guidance - which is whether markets will believe that rates will stay low once QE ends.

In his own words, Mr Bernanke said: "I hope I live long enough to read the textbooks."

Linda Yueh Article written by Linda Yueh Linda Yueh Chief business correspondent

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  • rate this

    Comment number 41.

    Is it correct to group King, Carney, and Bernanke in the same QE club? The UK QE expansion stopped a while ago - the next step perhaps will be to start the 'unwind'. However in the US they are still 'winding it up', still expanding QE assets and corresponding indebtedness. 'Tapering' over there means slowing down the rate of increase. Yes?

  • rate this

    Comment number 40.

    King, Bernanke and Carney are highly intelligent. Which college did you attend when you got your first from Oxbridge?
    Have you had experience of running a Central bank as well as posting on a BBC website?
    Surely these issues are not black and white but highly nuanced?

  • rate this

    Comment number 39.

    It appears that we, as individuals must live within our means.

    However Nations and especially powerful ones need not....If needed just print more and Q.E.

  • rate this

    Comment number 38.

    So it looks like all those junk bonds, cds, etc..which nobody wanted because they were toxic have been snapped up by the US Central Bank.
    Now what to do with these bits of IOU paper...File them away and maybe they will be forgotten about.

    Meanwhile the TRILLIONS of dollars printed to purchase said junk are now back on the Global Casino Tables.

    No more junk left...so that's it fixed then.?

  • rate this

    Comment number 37.

    America is nearly $17 trillion in debt and this year the Dow Jones has reached record levels. The whole concept of stock markets and financing an economy is ridiculous, its all smokescreens and mirrors and spivs in suits. No expert can predict anything with certainty, however the best maxim to follow should be to never take any financial advice from the US or from anybody in London either.

  • rate this

    Comment number 36.

    sooner or later the debts of all these countries trillions of $, £, etc will have to be defalted on, there is not a snow balls chance in hell it can be paid back. These people are in cloud cuckoo. Mad as march hairs, and they really think we believe what they say. We are all going to need some serious therapy in the not to distant future.

  • rate this

    Comment number 35.

    The hard part will be living within our means but since we have not done that for decades I don`t suppose anyone is seriously going to bother trying now.

  • rate this

    Comment number 34.

    1 Hour ago


    You probably appreciate we ain't seen nuffing yet




    #1 - keep printing, keep rates low
    #2 - stop printing, let rates rise

    Obviously, politicians will take #1 - but how long can we go on printing before the currency is debased?

    At that point, inflation and rates play lethal catch-up.

    So - gradual suffering now, or disaster later?

  • rate this

    Comment number 33.

    The key point is that there is only one way for interest rates to go and that is upwards.
    How long it will take is a matter for conjecture.
    I would be surprised if the interest rate hadn't risen to about 3% by 2017.
    Quantitative easing has worked in that it has stopped a spiralling depression.
    The trick now is to slowly engage quantitative tightening as the economy improves.

  • rate this

    Comment number 32.

    So bond-buying is going down by $M10 next month - but I'm not clear about when QE will end - it could go on for longer if inflation stays too low and unemployment stays too high. Just like ZIRP will go on for longer.

    Perhaps all of us won't live long enough to read about the end of this almighty mess, Mr B.

  • rate this

    Comment number 31.


    You probably appreciate we ain't seen nuffing yet - another 20 to 30 years of 'recoveries' before we achieve escape velocity (just like the 1870's Long Depression for the same reason, but this time only worse.)

    Are the fools that run the place so blind? Apparently! We have created the bubble/crash by forgetting the lessons of basic economics and history. King should have been sacked!

  • rate this

    Comment number 30.


    But why can so few people (& economists) understand the imperatives of the arithmetic?

    I really still find it difficult to underspend how appallingly poor the education of these people has become. King, Bernanke, Carney etc

    I was foolish and overestimated their intelligence and skills.

    Why do we have to put up with the same idiots who caused and then magnified the bubble/crash?

  • rate this

    Comment number 29.

    With interest rates (and other returns on investment) so low, the US (and the UK) have acted to deter capital formation. This amounts to an "investment holiday" with adverse implications for future productivity.

    At the same, this is a powerful deterrent to saving for retirement.

    Instead, we are inflating property - and properties are capital sinks which deny investment to worthwhile purposes.

  • rate this

    Comment number 28.

    27 Unlike the UK, US has bought unrated, illiquid debt instruments held on bank's ballance sheets or with investment and pension funds. The illiquidity of these instruments is key in temrs of when US comes to unwinding tappering. UK QE has been buying back of Gilts mainly from pension & Inv funds.

    Interesting how only other people are greedy!

  • rate this

    Comment number 27.

    It is nice to know the banks are doing so well. No doubt they will go out of their way to do the decent thing by the taxpayer who has facilitated their profitability - some sort of bonus would be nice but I suspect it will be the dark end of a burned stick as usual.

    So this might be the beginning of the end of QE. The story will no doubt continue with appropriate cries of woe from the greedy.

  • rate this

    Comment number 26.

    are we broke yet.. 24.
    Exactly right.
    Even the markets didn't take it too seriously.

  • rate this

    Comment number 25.

  • rate this

    Comment number 24.

    This HAD to happen before Bernanke left office. If the Fed had waited until Yellen took over and then had to reverse the decision she would loose all credibility. This way when QE is reinstated to previous levels or even expanded she can at least appear to be reacting to prevailing circumstances and come up with some cock and bull story to cover her backside.

  • rate this

    Comment number 23.

    will the last person to leave please close the door and switch the lights off - oopphs sorry blow the candle out!

  • rate this

    Comment number 22.

    Fed now holds some $4-TRILLION in assets, compared with less than $1-trillion before financial crisis. Fed will have to unwind this position without roiling financial markets which have grown used to monthly Q.E. "fix". Fed also risks losses as bonds will become less valuable as interest rates rise.
    Stocks up - sure.
    Economic position - NOT good.


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