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Why Bernanke's clearer message landed with a thud

Friday - 6/21/2013, 4:56am  ET

FILE - In this Wednesday, June 19, 2013 file photo, Federal Reserve Chairman Ben Bernanke speaks during a news conference in Washington. Mixed signals from the Federal Reserve have rattled investors for weeks. So Bernanke tried to set the record straight Wednesday about the Fed’s plans to shrink its bond-buying program later this year if the economy continues to improve. While investors didn’t necessarily like the content of Bernanke's message, there was little grumbling that he wasn't clear. (AP Photo/Susan Walsh, File)

MARTIN CRUTSINGER
AP Economics Writers

WASHINGTON (AP) -- Wall Street investors wanted clarity from Federal Reserve Chairman Ben Bernanke.

They didn't like it when they got it.

Bernanke set the record straight Wednesday about the Fed's bond-buying program. He said the Fed expects to scale back bond purchases later this year and end it entirely by mid-2014 if the economy continues to improve.

In response, investors dumped stocks and bonds in anticipation of rising interest rates.

The Fed has been buying $85 billion worth of Treasury and mortgage bonds a month since late last year. The purchases pushed long-term rates to historic lows, fueled a record-breaking stock market rally, encouraged consumers and businesses to borrow and spend and provided a crutch to an economy hobbled by federal tax hikes and spending cuts.

Confusion about the central bank's intentions set in last month after the Fed released a summary of its April 30-May 1 meeting: Several Fed policymakers said they were open to reducing the bond purchases as early as this week's meeting.

Bernanke, meanwhile, told Congress that the economy still needed help, but also that the Fed might decide to cut back the bond purchases within "the next few meetings" -- earlier than many had assumed.

The conflicting messages left investors bewildered. Just a hint of a pullback in the bond purchases sent bond prices plunging and their yields soaring.

So on Wednesday Bernanke, a former Princeton University professor, took pains to make the Fed's intentions as clear as possible.

Going beyond the formal statement the Fed's policy committee released after its two-day meeting this week, the chairman told reporters it would "be appropriate" to reduce the monthly bond purchases later this year and to end them by mid-2014 -- if the economy performed as well as the Fed expects. He said the bond-buying would probably end when the unemployment fell to "the vicinity of 7 percent" from May's 7.6 percent.

Bernanke explained that the rest of the Fed's policymaking committee had "deputized" him to expand on what fit "into a terse FOMC statement."

He said any reductions in bond buying, which keeps long-term rates low, would occur in "measured steps." And the Fed will remain flexible: If the economy proves weaker than expected, the Fed might decide to restore the higher level of bond purchases to try to drive down long-term rates again.

Plans to reduce the purchases are "very data-dependent, and that's important," says Joseph Gagnon, a former Fed official who is now senior fellow at the Peterson International Institute for Economics.

Bernanke likened any pullback in bond purchases to a driver letting up on a gas pedal rather than applying the brakes.

He stressed that even after the Fed ends its bond purchases, it will continue to maintain its vast investment portfolio -- which has ballooned to $3.4 trillion --to help keep long-term rates down.

The Fed is considering scaling back the bond-buying program because of its increasingly up-beat view of the economy. In its statement, the Fed said the downside risk to the jobs market had "diminished."

Fed officials predicted that unemployment will fall a little faster this year, to 7.2 percent or 7.3 percent at the end of 2013. They think the rate will be between 6.5 percent and 6.8 percent by the end of 2014, better than its previous projection of 6.7 percent to 7 percent.

They also reduced their forecast for inflation this year, but said the more-moderate increases in consumer prices partly reflected "transitory influences."

The Fed also said it would keep short-term rates at record lows at least until unemployment slides to 6.5 percent. Bernanke emphasized that 6.5 percent unemployment is a threshold, not a trigger: The Fed might decide to keep its benchmark short-term rate near zero even after unemployment falls that low.

"When we get to that point," Bernanke said, the Fed will "look at whether an increase in rates is appropriate."

One factor it will consider is inflation. If inflation falls too far below the Fed's target of 2 percent, it might decide to keep short-term rates at record lows. The goal would be to fuel more economic growth, which could lead to higher inflation.

Yet markets have been tumbling since Bernanke spoke. The Dow Jones industrials fell 206 points, or 1.4 percent, Wednesday and plunged another 200-plus points Thursday.

Investors dumped bonds, pushing the yields higher. The yield on the benchmark 10-year Treasury note rose past 2.40 percent Thursday to its highest level since August 2011.

The economists at PNC Financial Services Group said the market sell-off was probably an "overreaction" to Bernanke's comments. If the Fed scales back its bond purchases, after all, it would mean the economy is strengthening, something that should be good for corporate profits and for stocks.

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