In late May, Bernanke told Congress a decision to scale back the Feds $85 billion per month stimulus could be taken at one of its next few meetings. He made the Feds intentions even clearer on June 19, when he spoke openly of the reduction and eventual end of the programme, potentially by mid-2014.
The result was that a yield of 1.62% on the benchmark 10-year Treasury note in early May turned into a 2.75% yield by the beginning of last week, the swiftest rise in yields in a decade, though the market has since stabilised and the yield was back down to 2.54% late on Monday. The shock sent other bond markets tumbling, and global stock markets also plunged initially but have since recovered.
Indeed, US stocks are back around record levels, restoring more than $1 trillion in market capitalisation to the S&P 500 index as investors take the view that the equity market will be able to rally through a reduction in bond buying.
If I had to guess, Id guess that members of the Fed are much happier with market levels than they were three weeks ago, said Carl Tannenbaum, chief economist at Northern Trust in Chicago, noting signs that some heavy market bets have eased.
Fed officials did not welcome the steep back-up in bond yields and mortgage rates that Bernankes remarks caused, judging from the consternation evident in their comments since then to push back expectations of an early Fed rate hike. That has stoked suspicions that what policymakers were really worried about was a hidden build-up in risk-taking in bond markets that could have been the early signs of a bubble.
There may have been some concern at the Fed that there was too much risk being taken on, said Scott Brown, chief economist at Raymond James in St Petersburg, Florida. They have certainly taken care of that situation.
In the past, monetary policy that has encouraged too much risk has helped to foster bubbles that have burst with disastrous consequences, most recently the collapse of the US housing market that sparked the 2007-2009 financial crisis.
When asked if he wished that he had done things differently, Bernanke suggested roiling markets was a price worth paying. Notwithstanding some volatility that weve seen in the last six weeks, speaking now and explaining what were doing may have avoided a much more difficult situation at another time, Bernanke said at an economics conference last Wednesday, his first public remarks since the Feds June 19 policy meeting.
But he also emphasised that tapering of the bond buying would not be a signal the Fed would begin to tighten monetary policy sooner by raising the overnight interest rates from near zero, and pointed out that 14 of the Feds 19 policymakers anticipate the lift-off date for rates will not come before 2015.
The Merrill Lynch MOVE index, which estimates future volatility of long-term bond yields, spiked to around 111 following his June 19 news conference, up from a multi-year low of around 50 at the beginning of May.