Bernanke Surprises Investors with No Tapering

Federal Reserve Chairman Ben Bernanke

Federal Reserve Chairman Ben Bernanke

The Federal Open Market Committee issued a release today stating that although it has seen improvement in the labor market and economic activity since the beginning of its bond buying program, it will hold off on tapering its purchases. “The Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy. However, the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases,” the committee said in a statement.

Both retail and institutional investors reacted positively to the news; the S&P 500 index shot up 1% in the first hour after the committee’s decision was released.

In the Federal Reserve’s previous news release issued on July 13th, 2013, it stated that the federal funds rate of 0 – 0.25% would “be appropriate at least as long as the unemployment rate remains above 6-1/2 percent.” Of course, this is not a hard a fast rule. The unemployment rate is viewed with growing skepticism as it doesn’t include discouraged workers who have given up looking for a job given a defined period time.

A more stark portrayal of the overall employment rate is the labor participation rate, which was calculated at 63.2% in August 2013 according to data from the U.S. Bureau of Labor Statistics. The rate represents a 35 year low. In light of this, some members of the Federal Reserve board have proposed revising the unemployment target downward, but have met with opposition from other members. Those opposed believe that changing the target could weaken the credibility of the Federal Reserve and in turn cause uncertainty among investors.

Labor Participation Rate vs. Unemployment Rate – United States – Click to Enlarge

Source: U.S. Bureau of Labor Statistics

In a press conference this afternoon, Federal Reserve Chairman Ben Bernanke reiterated to reporters the dual mandates of the Federal Reserve: fostering maximum employment and maintaining price stability. He acknowledged the disparity in the unemployment rate and the labor participation rate saying, “The unemployment rate is not a fully representative indicator” of the overall labor outlook, but continued “most of the drop in unemployment is due to employment gains and not due to a lower participation rate.”

Bernanke was also pressed regarding the hints he gave in June that the Fed might begin tapering their bond purchases near the end of the 2013. Bernanke stressed that “communication” was a tool that would lend greater credibility to the Federal Reserve and that the Fed’s decision to put off tapering was “consistent” with those communications.

He conceded that the Fed may have been “overly optimistic about growth” and that a near zero federal funds rate will be likely to continue until 2016. However, he clarified that there would be “no calendar for policy” and that decisions about raising the rate and tapering purchases would occur “at the right time.”

CNBC reporter, Steve Liesman, asked Bernanke about his future plans and the supposed rift with President Obama. He declined to comment on his possible exit in January nor the possible nomination of Federal Reserve Chairman front runner Janet Yellen.

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