Research

Why Bernanke’s Words Worry the Market - July 23, 2013

The Federal Reserve Chairman, Ben Bernanke, has been relatively tight lipped since speaking in June following the Fed’s policy meeting. During last month’s conversation, the Chairman indicated that the Federal Reserve Bank would be tapering, then eventually ending programs of quantitative easing, the third round of such programs since the start of the recession. This was announced as well as suggestions that interest rates may rise if inflation continues at 2%, and unemployment drops to 6.5%. In the three days trailing this announcement, the stock market dipped 4.3% with the Dow Jones dropping 659 points. Not a single one of these policies were confirmed by Bernanke, but his mere mention of projected actions caused a significant drop in the market. On July 17th, Bernanke once again was slated to make public comments on the programs future, and news outlets lit up with speculation as to what would happen. So what exactly about these programs and their possible conclusion causes the market to stumble?

For starters, what has quantitative easing meant since the recession? In general, quantitative easing is a program adopted by a central bank in order to increase liquidity in the market when ordinary monetary policy has proven ineffective. Interest rates had been lowered to nearly nothing, yet failed to achieve the desired result following the recession. By late November 2008, the Fed began buying up billions of mortgage backed securities (MBS) in order to help the banks remain afloat. Once the economy began to improve in 2010, the initial program of quantitative easing was ended, but almost immediately the market began to dip again. This prompted what would become known as QE2, when the central bank bought $600 billion of Treasury Securities in November of 2010. September 2012 herald the start of QE3, with a bond buying program of purchasing $40 billion worth of MBS every month indefinitely. This amount was increased to $85 billion a month in December, which essentially relieved an equal amount of commercial housing market debt risk. And then came Bernanke’s statements following the June policy meeting.

On July 17th, he provided further edification as to what he had hinted at in June. An expected tapering of the bond buy up program from $85 billion down to $65 billion, with its eventual conclusion in 2014 was the only solid information given. In June he had stated that the tapering could being in September, following the next policy meeting, yet altered that original statement with an undetermined start date for the tapering, assuaging many of the worries that there would be large losses of liquidity. As for interest rates, he reaffirmed that for the foreseeable future, rates would remain near zero and were independent from the end of the bond buying program.

This seemed to pacify the fears of the market, with mortgage rates falling back down to 4.5% for a 30-year fixed rate mortgage. So what was the difference between Bernanke’s two talks, despite similar messaging? Largely, the difference is timing. With the first release, Bernanke set out very specific goals and time tables: QE tapering by September, ending by mid-2014, rates increasing once unemployment hit a certain threshold and inflation remained constant. This all set fairly clear expectations as to when things would happen, and it caused worry in the market. The congressional testimony had none of these timetables, and instead left the public with the message of “This will happen, but not soon.” He reaffirmed the tapering, but instead stated that it would not occur in the immediate future, with no end currently set. And he insisted that interest rates would remain as low as possible for some time more, and be reevaluated when we reached the previously mentioned thresholds, rather than a guaranteed increase at that point. This balanced Bernanke’s oft touted “forward guidance” in which he will preannounce Fed actions, with continued stability in the market.

But ultimately, what does this have to do with the housing market? A majority of the Fed policy focuses on monetary policy, with control of the interest rates being the main tool utilized. And while this does play a large part in determining mortgage rates, it is not the only factor. Yet the QE3 program’s purchase of MBS makes it much more impactful on the housing market directly. Bernanke acknowledged that the housing market’s solid growth since the recession has played a large part in helping the economy at large make gains, and attributed part of that housing growth to the Fed’s program. Would the end of the program spell the end of gains being made? The overwhelming response so far has been no. Home values have continued to rise, and this encourages more housing starts, results in fewer mortgages being underwater, and ultimately means they’re on track to withstand any impact resulting from the conclusion of QE3. While mortgage rates have been pushed up in anticipation of rising interest rates, Bernanke’s comments pushed them back down, and they remain at historical lows. So while the news and stock market brace themselves every time Bernanke is slated to speak, the housing market continues to make gradual gains.

 

Sources:

“Chairman Ben S. Bernanke Semiannual Monetary Policy Report to the Congress”. July 17, 2013.http://www.federalreserve.gov/newsevents/testimony/bernanke20130717a.htm

Graham, Matthew. “Mortgage Rates Lower After Bernanke Testimony”. Mortgage News Daily. July 17, 2013. http://www.mortgagenewsdaily.com/consumer_rates/316952.aspx

Walsh, Alex. “Dow Jones down 4.3 percent since Fed chair Ben Bernanke took the podium”. All Alabama. June 24th, 2013. http://www.al.com/business/index.ssf/2013/06/dow_jones_down_43_percent_sinc.html

View All Articles