During the week of June 17, Federal Reserve Board Chairman Ben Bernanke and the Federal Open Market Committee issued a statement that the U.S. economy is improving faster than the Fed’s economists expected. Therefore, if there were continued improvement, the Fed would scale back its Quantitative Easing Part 3 (QE3) program of buying Treasury and mortgage-backed securities, and ease back on stimulating the economy and keeping interest rates low.
Everyone knows that the Fed will eventually phase out its market interventions. They have been announcing this ever since their interventions began while emphasizing that the phase out would be based on the strength of the economy. Nothing in the statement suggested that the Fed had any immediate plans to stop buying altogether; the intention is only to ease back as it becomes less necessary. The implication is that this eventual easing could take place as early as this Fall, and only if the unemployment rate falls faster than expected.
This situation reminds me of a conversation I had recently with some clients who are becoming serious about retirement planning. They have one daughter in graduate school and another daughter about to begin her senior year as an undergraduate. The parents are funding each daughter’s education to the tune of $50,000 per year. The parents are anticipating (and planning) that the day is coming when this expense will disappear from their profit and loss statement. They have made it clear that they expect their daughters to finish their education and become financially independent, and that when this occurs, the $50,000 per year distributions will also cease.
Bernanke’s statement is similar to the statement my clients have made to their daughters: You need economic help now until you become economically productive on your own. Once you can stand on your own two feet, I won’t need to help you or help you as much. It is a matter of common sense.
Oddly enough, the result of the Fed’s common sense statement was panic on Wall Street, causing the S&P to lose 1.4% of its value on June 19 and 2.5% on June 20. It could be that too many investors heard something different from what the Fed actually said. Instead of hearing “We plan to ease back when we believe the economy is back on its feet,” they apparently heard something like, “The Fed is ending its stimulus now!”
When our children were young, we would give them a 30-minute warning about their approaching bedtime. Sometimes they would push back when they heard this announcement as if they were being sent to bed immediately. I think Bernanke is using a similar tactic with investors. He is letting us know that at some point the stimulus will end because it will not be necessary. We never broke trust with our children by suddenly changing their bedtime from 8 pm to 7:35 pm. The Fed will not break trust either. They will ease up when the economy is strong, not when it is growing at 1.8% annually.