Diane Swonk, Chief Economist
Feb. 10, 2010 – 10:10 a.m. CT
Fed Readies Markets for an Exit
Fed Chairman Ben Bernanke today released his prepared testimony on the Fed's exit strategy to the House Financial Services Committee. This was released despite the fact that the actual hearing was cancelled, as government offices in Washington, D.C. are still closed due to inclement weather – they are still buried in snow – temporarily sparing the Fed Chair the flurry of ignorant questions and political posturing that has plagued these hearings in recent months.
The key take-aways from the Chairman's comments are:
- Financial markets are significantly more stable than they were a year ago, and the existing strategies for stabilizing markets will continue as planned. In particular, the Fed hopes to stop its purchases of mortgage-backed securities as planned in March (financial markets are still jittery on this point, as mortgage applications fell in the most recent week).
- The Fed does not believe that it will lose any money from loans or taxpayer dollars given to Bear Stearns, and later to AIG, to shore up their liquidity positions during the crisis.
- The Fed is exploring alternatives to the fed funds rate to better capture the stance of monetary policy – most notably the interest paid on bank reserves – in the coming months, as the fed funds target has become a less reliable gauge of actual monetary conditions. It plans, however, to return to a simple fed funds target once financial and economic conditions normalize.
- And, although the Fed does not anticipate that it will have to tighten aggressively over the next year, it will not hesitate to accelerate its exit strategy by raising rates and selling the securities that it holds, more rapidly.
The Bottom Line: There was really no new news about the timing of the Fed's exit strategy today. There was, however, more information about ways in which it can test and execute a strategy in the months to come. Markets reacted a bit negatively on initial reports that the Fed was moving forward with its exit strategy and will eventually begin raising rates, but bank stocks rallied. A larger weight on the broader market indices in the near-term is uncertainty regarding the financial situation in Greece.
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