Jittery global markets waiting for clarity from the Fed meeting

WASHINGTON - Agence France - Presse

The decision that will come out of the Fed’s meeting tomorrow over the pace of its monetary easing program is curiously awaited particularly by emerging markets that are easily affected by panic. AFP photo

The Federal Reserve’s policy board meets tomorrow to review the economy and its stimulus program, and markets are looking for one thing: clarity.

After weeks of tumultuous stock market volatility and a sharp fall in bond prices, bankers, investors and anyone else with a vested interest are waiting to hear: is the Fed really about to reel in its quantitative easing program? If so, could that be within months? Or will the US central bank wait for stronger economic growth to take that step? The markets eagerly await any meeting of the Federal Open Market Committee, which sets the benchmark US dollar interest rate and, at the moment, continues to hold long-term rates down with its $85 billion-a-month QE bond buying program.

But much more rides on this FOMC meeting tomorrow and the day after tomorrow, because over the past month billions of dollars have been bet on an aggressive interpretation of comments by Fed chief Ben Bernanke that the Fed is about to turn the corner on five years of stimulus.

The belief that it will start tapering its bond purchases within months has sent bond prices plummeting and interest rates shooting up, and that, in turn, has pulled stocks lower, after they reached new records fueled by the Fed’s easy money policy.

Yet US economic growth slowed slightly in the spring and remains at risk to slower growth around the world, and with the government slashing spending, Fed stimulus is still needed, economists say.

The Fed’s guideposts, unemployment and inflation, remain far off their target for a “normalized” fiscal policy. The unemployment rate is hovering at 7.6 percent – the target is 6.5 percent – and inflation is well below the 2.0 percent level the FOMC sees would be healthy.

Most analysts say that means that the FOMC is likely to stay the course in this meeting.

But how Bernanke hones his hints on future policy in a post-meeting press conference Wednesday will be key.

“We do not expect Mr. Bernanke to yet show confidence that the time to taper QE is near,” said Carl Riccadonna at Deutsche Bank.

“But the most important aspect of his media Q&A will be whether he signals that a second-half taper remains plausible.” The bond market has decided. The yield on the 10-year Treasury bond shot up from 1.63 percent at the beginning of May to 2.23 percent in the past week, and the 30-year jumped from 2.82 percent to 3.38 percent. Partly behind that were the seeming at-odds comments by Bernanke to Congress on the issue on May 22.

Fears of 1994

He first warned that tightening monetary policy now could stall the US recovery. But moments later he said the Fed could decide to start reining in stimulus in its “next few meetings,” taken as meaning as within months.

Since then stock markets have swung wildly from day to day as investors hang on every economic data point to confirm or weaken the interpretation that cutting QE is nigh. Yet Bernanke has been at pains to stress that the tapering QE purchases would begin only if the economic data supports a picture of a consistently improving economy.

And the Fed has not yet concluded that, with US industry and employment still growing slowly. Still, there are reasons for nervousness. Many investors fear a repeat of February 1994.

Likewise a time of a tepid turnaround from recession, and with no evidence of inflationary pressures, the Fed without warning raised its benchmark federal funds rate for the first time in five years, and did so repeately over the next 10 months for a rate hike totalling a massive 2.5 percentage points.