Fed Keeps Stimulus Steady: How Could Wall Street Have Gotten It Wrong?

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At the risk of stating the obvious, the Federal Reserve and Wall Street are in the same boat, but hardly rowing in the same direction. Quite the opposite in fact. The general consensus on the Street was that Mr. Bernanke would announce yesterday that the Fed would start to withdraw its economic stimulus in baby steps beginning this month. It’s not as though analysts pulled the information for their assessment out of thin air. The Fed has been sending signals for months. In May Bernanke implied that the Fed would soon start to wind down its efforts to stimulate borrowing and economic growth. Then, at its June meeting, the Fed said (not implied) that the economy was almost strong enough to begin doing without the full stimulus program. Logic dictated that with the September meeting, Bernanke would make the announcement of a tapering of some sort. Right? Wrong. And now confusion reigns; at least at home.

World shares and global bond prices surged today and the dollar fell after the U.S. Federal Reserve dumbfounded markets by opting to defer plans to cut back its asset buying program. The Federal Reserve also cut its projection for 2013 economic growth to a range of 2.0 percent to 2.3 percent, a drop from a June guesstimate of 2.3 percent to 2.6 percent. The downgrade for 2014 was sharper.

On a global scale, investors have spent the better part of the summer getting used to the idea that the stimulus efforts made by the central bank would soon be easing. As a result, interest rates began to rise which, in turn, hurt many emerging markets who had come to rely on lower rates. With the news that economic stimulus would not be tapering, global markets heaved a collective sigh of relief and began popping almost immediately. The Turkish lira and Indian rupee rose more than 2 percent. Indonesia’s stock index climbed 4.8 percent, the Philippines index 3.1 percent, Australia 1.1 percent, and Japan’s Nikkei 1.8 percent.

Some economists believe that the Fed deliberately misled Wall Street to dumb down speculation in risky financial ventures and to push up interest rates. There may be more truth to this idea than meets the eye. On Wednesday, Bernanke said that he was glad to see the sell-off over the summer of risks such as junk bonds. Conversely, he also stated that he was not pleased with the broader rise in interest rates, which had driven up prices for mortgages and other types of consumer loans.

To be fair, the Fed is walking a mighty thin tightrope. It’s well aware that its decisions regarding economic stimulus have a huge impact on not only the U.S., but the global economy as a whole. Its decision to keep its asset buying at $85 billion a month is a hedge against the sharp rise in Treasury yields over recent months, which have been proving to be a headwind for the housing market and the U.S. economy over-all.

Although the decision by the central bank is ultimately a good thing for investors, there was a flaw in the way the Fed communicated their intent on when and if they were going to taper their bond-buying spree. Wall Street thought they had it right and made plans accordingly. Now they are in a position to point an admonishing finger. Seriously, get over it.