Ben Bernanke, chairman of the Federal Reserve, sure knows how to stir up some controversy.
After his speech last week about the eventual tapering of the open-ended third-round of quantitative easing program, and the Federal Open Market Committee meeting minutes pointing to tapering assets as soon as June, the markets went haywire.
But don’t overlook the coincidental timing of Bernanke’s speech and the FOMC’s meeting minutes — the central bank knows exactly what it’s doing.
Here’s the big question for the Federal Reserve — mortgage rates are up 50 basis points over the past month, at 52-week highs — is that the reaction the central bank expected to get from the market when they announced that it will wind down its quantitative easing program sooner rather than later?
I think not.
The Fed misjudged how the market would react to the mere introduction of the topic of slowing its purchases when/if conditions improve, according to Keefe, Bruyette & Woods.
"In our view, the Fed wanted to make clear that the current 'open ended' purchase operations were not permanent, which it probably felt was necessary to prevent the market from reacting violently when it eventually has to signal that it will be slowing," analysts for KBW explained.
They added, "In our view the market has become hypersensitive to this kind of thing, which it’s probably healthy for the Fed to figure out and internalize."
The Fed has taken on its role as Yoda: repeatedly emphasizing the importance of communicating its intentions clearly to the market — leading to explicit thresholds like 6.5% unemployment and inflation that only exceeds its longer-term target of 2%.
It’s quite ironic that the more the Fed talks about the need to communicate clearly the more the markets read into every new world introduced into the dialog.
To put it simply, the market is overreacting.
But what would it take for the market to reverse its views? Time.
"Time passes, the fears don’t materialize, and the group trades back higher. We suspect that’ll be the answer this time too," KBW stated.
The market needs to stop being over analytical, but at the same time, stay alert about the overall picture being painted — the Fed is going to wind down QE3, it’s just a matter of time. Instead of blindsiding the market, the central bank is trying to prepare us for the inevitable.
In the famous words of Yoda, "Much to learn you still have, my old Padawan. This is just the beginning!"