Markets 'overreacted' to taper, ex-Fed chief says


by Robert Hennelly

Source: CNBC

The Federal Reserve likely will start pulling back its stimulus program soon, but that doesn't mean interest rates are going up, former Dallas Fed President Robert McTeer said.

After the June Fed Open Markets Committee meeting, Chairman Ben Bernanke rattled markets when he disclosed that the central bank was likely to begin tapering its $85 billion a month in bond purchases this year, with an end date of 2014.

The markets mistook that to indicate that the Fed might start tightening policy by raising rates simultaneously.

McTeer said that while the asset purchases will begin slowing soon, that doesn't mean a rate reversal is imminent—meaning the market is confusing tapering with tightening.

"A lot of people in the market overreacted to talk of tapering," he told CNBC.com. "It's an absolutely natural thing to do. It does not mean tightening monetary policy, as the chairman continues to emphasize."

Bernanke's biggest potential mistake would come from trying to do too much to preserve his legacy, McTeer said.

"It may be unfortunate that his term is up when it is. It may put a little pressure on him to make some moves before he leaves that will put the Fed on the course he thinks it will be on," McTeer told CNBC.com. "I worry that his departure might cause him to do that prematurely."

The Fed's calculus in deciding when and how it will begin pulling back on its twin stimulus programs of bond-buying and near-zero interest rates has been critical to marker behavior.

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Minutes from the June FOMC meeting indicated that half the committee members would like to see the bond-buying—quantitative easing—unwound this year.

That's the kind of pressure that McTeer worries could disrupt an orderly exit from the Fed's extraordinary easing programs. In addition to keeping its target funds rate near zero, the central bank has expanded its balance sheet to $3.54 trillion.

"There's some pressure on the chairman to sort of see this thing through before he leaves," he said. "That might cause him to act prematurely."

Bernanke's second four-year term ends Jan. 28, 2014. He is widely not expected to return.

Markets are pricing in a September start to the tapering process, according to the latest New York Fed primary dealer survey. That's an acceleration from the last survey, which saw a pullback beginning in December. 

The expectation is that the first target will be the $45 billion a month the Fed is purchasing in Treasurys. Goldman Sachs economists predicted those buys will get cut by $20 billion or so a month, while the MBS purchases hold at $40 billion.

"A number of Fed officials have generally described MBS purchases as more effective at stimulating the economy than Treasury purchases, in essence having more bang for the buck," Goldman economist Kris Dawsey said in a note to clients. "Furthermore, the Fed has demonstrated a particular interest in supporting the housing market, which we think it would be unlikely to want to endanger."

But with some level of uncertainty still looming, McTeer said he wishes Bernanke would stay on another year.

Failing that, he said he is not in favor of any of the popular candidates being bandied about—San Francisco Fed President Janet Yellen seems the most likely successor—but rather prefers Princeton economist Alan Blinder.

Blinder is the former head of President Bill Clinton's Council of Economic Advisers and served as vice chair of the Fed's Board of Governors.

"He showed you can be caring and have empathy for the poor and so forth while not going crazy with your economics," McTeer said.

As far as policy is concerned, McTeer expects the market's worst fears about QE withdrawal not to be realized.

"For a long time all the pundits were saying quantitative easing was a bad thing. Suddenly everybody seems to be addicted to it. I think maybe that has loosened since May," he said. "Regardless of what they do on QE, overall monetary policy is going to remain accommodative."