Call it a stimulus by omission.
By not doing anything, the Federal Reserve kicked off a market rally Wednesday afternoon.
Many investors expected the central bank to announce that it would start reducing the amount of stimulus bond purchases it makes each month from the current $85 billion level. So the Fed's announcement that there would be no changes and that the program would go on as before led to an immediate spike in the stock markets and a drop in Treasury bond yields.
Fed Chairman Ben Bernanke was unapologetic about the surprise in a press conference following the Fed's statement, telling a reporter, “I don't recall stating that we would do any particular thing in this meeting” when asked if he was worried that he had confused investors once again.
Overall, Bernanke struck a much more dovish note than he has in recent appearances.
He said the decision to keep buying $85 billion in bonds was a "precautionary step,” and that the Fed wants to “wait a bit longer and to try to get confirming evidence” that the economy continues to grow as hoped.
But he also backpedaled from his earlier statements about beginning to wind down the bond purchases soon. In May he said that the Fed would start reducing the size of the purchases “in the next few meetings.” And in June he indicated that the Fed wanted to wind down its quantitative easing program altogether by the time the unemployment rate falls below 7 percent.
On Wednesday he backed off from both the timeline and the unemployment rate threshold for tapering the asset purchases.
He said the taper could come “possibly later this year,” and dismissed the 7 percent unemployment rate benchmark as just “an indicative number to give you some sense of” what kind of labor market improvement the Fed was looking for. The current unemployment rate is 7.3 percent, according to the Bureau of Labor Statistics.
Instead, Bernanke said, the Fed’s decisions will be based on how well the economy improves. “Asset purchases are not on a preset course,” he explained. “They are conditional on the data, they've always been conditional on the data.”
Altogether, the message from Wednesday’s Fed policy announcement and press conference clearly suggested that U.S. central bankers are committed to keeping the stimulus program in place until job growth picks up, economic output rises faster, and inflation picks up.
“Clearly, the doves — focused predominantly on labor market slack and a fragile housing recovery — prevailed at today’s meeting,” Deutsche Bank economists wrote in a note following the announcement.
Although stocks and bonds rose in price following Wednesday’s meeting and announcement, interest rates on U.S. Treasury bonds and mortgages remained well above where they were in May, before Bernanke first hinted at tapering the bond-buying program. Yields on the 10-year U.S. Treasury fell to 2.70 percent, after being close to 1.50 percent in early May. Similarly, the rate on 30-year fixed-rate mortgages closed near 4.50 percent, after being as low as 3.5 percent earlier in the year.
The Fed’s monthly purchases consist of $45 billion of Treasury bonds and $40 billion of mortgage-backed securities.
Four regional Federal Reserve Bank presidents and a member of the Fed's Board of Governors are slated to give public speeches in the next two days. It is possible that they could add further clarity to Bernanke's comments and present a different view of the direction of Fed policy. After a surprisingly hawkish press conference by Bernanke in June sent stock markets lower and bond yields higher, a number of his colleagues at the Fed suggested that his remarks had been misinterpreted in speeches over the course of the following days. If investors overreacted to Bernanke's speech Wednesday, there could be a repeat episode.