Top officials at the Federal Reserve spent the past week trying to reassure anxious investors that the central bank’s target interest rate will remain low even as it prepares to scale back its multibillion-dollar stimulus effort.
In separate public remarks this week, nine of the Fed’s top brass emphasized that their decisions would be guided by the condition of the economy. If the recovery picks up momentum, they could withdraw support more quickly. But if it stumbles, Fed officials noted, they could always delay.
The parade of Fed speeches was notable not only because of the sheer number, but also because the officials sounded the same note of caution. Several suggested that recent market volatility indicated investors had interpreted their message incorrectly. Their remarks amounted to an effort to set the record straight.
“Market adjustments since May have been larger than would be justified by any reasonable reassessment of the path of policy,” Fed Governor Jerome H. Powell said in a speech Thursday in Washington.
Those movements were amplified over the past week after Fed Chairman Ben S. Bernankeoutlined a tentative timetable for ending $85 billion a month in bond purchases. The program was intended as a temporary stimulus to push down long-term interest rates. It has been credited with lowering the cost of mortgages and stoking demand for housing.
Bernanke said last week that he expects the economy will be strong enough for the Fed to begin scaling back its bond purchases this year. He said the program would likely end when the unemployment rate hits 7 percent, which is expected to occur in mid-2014.
Markets seemed ill-prepared for the news, however. Major stock market indexes swung as much as 2 percent in recent days. Bond yields spiked, sending the cost of mortgages up. The average interest rate for a 30-year fixed loan jumped half a percentage point over the past week to 4.46 percent, according to Freddie Mac, which is the highest level in two years.
In their remarks, Fed officials pushed back against the sense that winding down its stimulus program amounted to pulling on the reins of the recovery.
They stressed that the Fed intends to keep its benchmark interest rate near zero at least until the unemployment rate reaches 6.5 percent or inflation rises to 2.5 percent. The majority of the Fed’s top officials do not expect that to happen until 2015.
Even Richmond Fed President Jeffrey M. Lacker, a vocal opponent of the central bank’s bond buying, emphasized that officials would not raise interest rates prematurely, likening their stimulus efforts to punch at a party.
“The Federal Reserve is not only leaving the punch bowl in place, we’re continuing to spike the punch, though at a decreasing rate over the next year,” he said Friday in West Virginia.
Meanwhile, San Francisco Fed President John C. Williams pushed back his timeline for slowing down bond purchases. In April, he suggested that the central bank could taper them this summer. But on Friday, Williams said he would like to see more data showing the recovery can withstand federal government spending cuts. In addition, he noted that inflation has been too low.
“So, is it time to act? My answer is that it’s still too early,” Williams said.
But the purchases eventually will end, and the past week underscored the challenge the Fed faces in communicating how the process will work and what it means. A muddled message can not only rattle markets, but also limit the Fed’s ability to act.
“Market expectations influence [the central bank’s] actions,” Fed Governor Jeremy C. Steinsaid Friday in New York. “It is difficult for the committee to take an action at any meeting that is wholly unanticipated because we don’t want to create undue market volatility.”
I want to emphasize the importance of data over date. The path of purchases is in no way predetermined; we will monitor economic data and adjust our purchases as appropriate.
Market adjustments since May have been larger than would be justified by any reasonable reassessment of the path of policy
there are limits to how much even good communication can do to limit market volatility, especially at times like these.