May 2nd, 2011 | By Nick SargenAmid all the uncertainty about the wind down of the Federal Reserve’s quantitative easing program (QE2), it was nice to have Fed Chairman Bernanke answer questions in a press conference on April 27. This marked the first time in the Fed’s history that it held a press conference immediately after an FOMC meeting. Indeed, prior to 1994, the Fed did not make any announcements – written or verbal – about policy changes.
What did we learn from the conference? Not much that was different from our expectations going into the meeting.
Chairman Bernanke confirmed that monetary policy would stay on hold for an “extended period”, and he indicated that the hurdle for a new round of easing had been raised. When he was asked to explain what that term “extended period” meant, he responded that there will be “a couple of meetings” between the time when the “extended period” language is dropped and the first interest rate hike. In that respect, at least, the press conference offered some clarification of the Fed’s thinking.
Another issue that was clarified related to the plans the Fed has for the balance sheet of securities it holds. For the time being, the Fed plans to keep its balance sheet intact once the QE2 program is completed in June. This means it will replace expiring securities as they roll off the books. Bernanke went on to add, however, that the reinvestment of maturing securities will stop “early in the exit process.”
Based on this, it appears that the first step in the Fed’s exit strategy will be allowing the balance sheet to shrink via expiring securities, and that it will wait to increase short-term rates until the Committee is satisfied the economy is on solid footing. According to Bernanke, the timing of these moves is uncertain, as “it will depend on the evolution of the economic outlook.”
As regards inflation, the Chairman’s message was that the headline inflation rate was likely to breech the Fed’s long-term target of 2%. But this was mainly due to rising oil prices, which the Fed believes will be temporary. The Fed is comforted by the fact that measures of long-term inflation expectations have not changed very much.
While Chairman Bernanke’s message is consistent with my impressions of Fed policy, I am somewhat surprised by the response of financial markets: Risk assets rallied, commodity process surged, while the dollar plummeted. My interpretation is that, after having heard the Chairman explain monetary policy first hand, market participants have even greater conviction that the Fed is not about to change policy anytime soon.
To be sure, some observers believe the Fed is being too lax and contributing to commodity price inflation. For the time being, however, bondholders are siding with the Fed, as Treasury yields remain within recent trading ranges.