QE Tapering Will Prevent Market Distortion

Federal Reserve Chairman Ben S. Bernanke has a choice: Sacrifice stimulus by trimming bond purchases or risk market distortion by further expanding the Fed’s $3.5 trillion balance sheet. Last week’s payrolls report gives him cover to cut.

That doesn’t make Bernanke’s decision any easier: Economic growth and inflation remain short of the Fed’s expectations, which might argue for keeping up bond purchases at an $85 billion-a-month clip. On the other hand, dialing back quantitative easing, or QE, would signal to investors that they don’t need to reach for yield by piling into risky securities.

“There is nothing on the economy side to have precipitated such a seismic shift in their approach to QE,” said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut, and a former researcher at the Richmond Fed.

“They are finally starting to grasp what the signal from QE has done to the markets,” Stanley said. “QE was contributing to a market environment where people were taking too much risk. The beginning of tapering in September is a lot more predetermined than the Fed is letting on.”

In a June 19 press conference following two days of meetings by the policy-making Federal Open Market Committee, Bernanke said the central bank may start scaling back its bond-buying program this year and end it in mid-2014 if the economy achieves the Fed’s growth objectives.

Bloomberg

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