Ben Bernanke will 'attempt to pour oil on the slightly turbulent financial markets'

Kim Fæster at Jyske Bank tells us what markets should prepare for:

Ben Bernanke, Chairman of the Fed, is facing somewhat of a task on Wednesday night at 8.30 pm.

He is to calm the markets but he cannot eliminate market fears of what the Fed forecasts, that is the scaling down of purchases of government and mortgage bonds.

In this research report we will take a look at Bernanke's possibilities prior to the Fed meeting.

Long-term bond yields have risen and equities have fallen following Bernanke's latest speech to Congress (22 May).

At that point he assessed that the Fed would be able to initiate the scaling down of purchases on the next few meetings (19 June, 31 July and 18 September).

Most economists do not expect the scaling down to materialise until Q4 2013, and many market participants believe that the Fed will not scale down the purchases until sometime next year.

The markets are not quite aware that the Fed requires, for instance, a rather solid advance in the labour market before the scaling down can be initiated. Consequently, the announcement from Bernanke was interpreted as an indication that the Fed might initiate the scaling down before the markets expect so.

An announcement from BoE's head of financial stability signalled that the increase in long-term yields is not to be taken lightly. He estimates that the greatest risk for the global financial stability is that long-term yields will surge when the central banks withdraw their stimulant measures.

No fundamental changes on Wednesday

We do not think that Bernanke will fundamentally change the announcement that the scaling down will be implemented, but rather the time horizon. The Fed will not continue the purchases to the same extent, if its expectations of accelerating growth in H2 and 2014 hold true. We believe that Bernanke will focus on what a scaling down will require. There are, basically, three conditions:

• Solid growth in employment
• Relatively certain expectations that this will continue
• Or, alternatively, that the Fed will be less concerned about the risk of decelerating growth.

He could specify what solid growth in employment means, for instance average job growth of more than 200,000 for four to six months on end, concurrently with inflation still being relatively close to the Fed's target of 2%.

None of the targets are currently fulfilled (job growth is 153,000 over the past three months, and inflation is 1.1%, which is the lowest level since the early 60s). This will lower expectations that the Fed will scale down its purchases at the next few meetings.

Exit strategy is also a possibility

Another possibility is that the Fed will launch a more comprehensive exit strategy for the purchase programme, where focus is on symmetry. This means stressing that if the economy grows too slowly, the purchase programme may be increased. This could, for instance, be formulated as:

• job growth of more than 200,000 for six months on end - scaling down of purchases by USD 20bn per meeting;
• job growth of less than 150,000 for four months on end - stepping up of purchases by USD 20bn;
• this might be coupled with an inflation target.
  
  

International considerations

The Fed is also squeezed in other respects than the domestic economy. Not only have long-term US yields increased, but they also pushed up long-term international yields. Especially EM yields rose considerably, and even European yields have risen. And although the Fed estimates that the US economy can cope with the yield rises, this does not necessarily apply to other countries recording yield rises. This may put a damper on international growth.