Bond markets dictate Fed policy!

U.S. Federal Reserve chairman Ben Bernanke in his press conference after FOMC meeting on September 18 said “we can't let market expectations dictate our policy actions”, when asked about Fed tapering. But Federal Reserve did exactly let bond markets to dictate or reverse their policy guidance communication.

From last 4 months Fed wanted to prepare markets for the reduction in bond buying program. Various governors irrespective of their dovish or hawkish stance, they talked about either for or against tapering of bond buying. They communicated and convinced markets that Fed is expected to announce tapering of the bond buying in September meeting by $10 billion as per overall consensus in the markets.

When Fed started talking about tapering Benchmark bond yield started soaring and reached peak of 2.9% recently. Before tapering news hit the markets, Benchmark 10 year bond yields were around 1.6% in early May of this year. They jumped 130 basis points as heavy sell off in treasuries incurred. 30 year U.S. mortgage rates jumped to 4.2% from 2.8% around 50% jump! Markets started filtering in the news of Fed tapering.

After yesterday's FOMC meeting, in its press release, Fed said, “The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall, but the tightening of financial conditions observed in recent months, if sustained, could slow the pace of improvement in the economy and labor market.” In last 4 FOMC statements, Fed used almost same language “the committee sees the downside risk to the outlook of the economy”. Where as in this meeting it talked about concerns over financial tightening conditions in recent months!

In fact recent surge in bond yields is caused by Bernanke and his colleagues’ talk of tapering. They communicated their policy guidance as usually all central banks try to maintain the transparency in their policy guidance communication and their thought process.

Actually short term money markets eased in this span of 4-5 months. Below is the table in which all indicators indicate short term borrowing rates eased in all category.

Money market indicator	May 1, 2013	September 17, 2013	Change
2 week repo	0.17%	0.08%	-52%
3 month repo	0.16%	0.08%	-50%
2 week mortgage repo	0.21%	0.10%	-52%
3 month mortgage repo	0.20%	0.13%	-35%
Fed fund rate	0.15%	0.09%	-40%

Here question is not about whether economy started recovering or started creating enough jobs; it’s about how the world’s biggest central bank failed in judging economic scenario and failed in their communication. Many referred it as “surprise”, I would like to call it call as shocking. Surprises can be like Paul Volcker doubling Fed fund rates from 10% to 20% between 1979 and 1981 to tame the inflation. But not this one, where Fed prepared the markets for tapering and in turn markets convinced Fed not to taper!