The Federal Reserve’s surprise decision Wednesday to maintain a controversial bond-buying program keeping interest rates low to prop up the U.S. economy sparked a Wall Street rally. It also served notice that partisan politics and rising mortgage rates threaten an anemic recovery.
Wall Street had expected the Fed to signal its confidence in the economy and begin tapering off its purchases of $85 billion a month in government and mortgage bonds, which has helped keep interest rates at record lows.
Instead, the rate-setting Federal Open Market Committee said that it decided to “await more evidence that progress will be sustained before adjusting the pace of its purchases.”
The committee also released an updated economic forecast, downgrading its views on economic growth prospects for the rest of this year and 2014. The surprise was welcomed heartily on Wall Street, where investors tend to buy more stocks when they can’t make any money off low interest rates. The Dow Jones industrial average shot up in late afternoon trading, closing up 147.21 points to 15,676.94. The S&P 500 rose 20.76 points to 1725.52, and the NASDAQ finished up 37.94 points to 3783.64.
For Americans with 401k investment plans, the action is likely to boost the value of their portfolios. But the reasons for the Fed decision to keep buying bonds carry worrisome implications for ordinary Americans, too.
In a news conference, Bernanke pointed to a sharp rise in the lending rate for mortgages, caused by fears that the bond buying would end. “We are somewhat concerned, I won’t overstate it,” the Fed chief said, noting concerns that the climbing mortgage rates just as the housing market recovers “would be exacerbated if conditions tightened further.”
Bernanke returned on several occasions to the theme of mortgage rates as one reason why the Fed decided to hold off on beginning to wind down a program that critics charge is distorting financial markets the world over.
“It was a precautionary step,” he said. “The intention is to wait a bit longer and try to get confirming evidence that the economy is in fact conforming to this general outlook we have.”
Asked if he felt he’d misled markets into expecting a change in Fed policy, Bernanke responded icily. “I don’t recall saying we would do anything particular at this meeting,” he said. “We can’t let market expectations dictate our policy action.”
The Fed has no easy choices presently on when to end economic support that has no real precedent.
“Policymakers seem to believe that fiscal policy will hold the economy back and that as long-term rates rise, housing will be affected negatively. So, they decided to keep pouring fuel on the fire for now and wait for stronger data before curtailing bond purchases,” said Dean Croushore, an economics professor at Virginia’s University of Richmond and co-author of a textbook with Bernanke. “The danger is that if they wait too long, they will have to tighten quicker and interest rates may rise rapidly, with more deleterious consequences.”
Bernanke also cited concerns about a possible government shutdown if warring political parties can’t pass a budget or an extension to fund the government past Sept. 30. He also cited the fear the government could reach a statutory debt ceiling around mid-October and run out of authority to borrow to pay bills already incurred.
Cautioning the Fed could do little to ameliorate economic damage from a voluntary default on existing government debt that “could have very serious consequences,” Bernanke said that “if these actions led the economy to slow, then we’d have to take that into account surely.”
Translation: The economic fallout from political battles could mean the Fed leaves in place the bond buying well into next year. As it stands, the Fed chief said 12 of the 17 members of the rate-setting committee now believe the Fed will only be able to begin using its conventional tool, raising its benchmark interest rate, in 2015. Two members thought 2016 would mark the start.
For average Americans, this means that the Fed hopes to keep the cost of borrowing extraordinarily low for consumers and businesses for several more years. The Fed’s revised economic forecast Wednesday now envisions the growth rate next year to land between 2.9 percent and 3.1 percent. That’s lower than its forecast in September of a 2014 growth rate of 2.9 percent to 3.6 percent.
Bernanke’s second term ends in January, and the decision of replacing him has become unusually political, with contender Lawrence Summers, an Obama confidante, bowing out on Sunday to avoid a contentious confirmation process. The world’s most influential banker, Bernanke declined to say whether he told the president he did not want a third term or if the president told him he would be nominated for a third term.
“I prefer not to talk about my plans,” the Fed chief said when asked if he might stay for a third four-year term. He promised to discuss his future at a “reasonably soon date.”