As was widely expected and well leaked, Ben Bernanke unveiled the Fed's "exit strategy" today in prepared testimony for the House Financial Services Committee.The market's reaction to the testimony has been fairly mild but some traders apparently believed "for an extended period" meant "forever." There was a lot of gnashing of teeth over Bernanke's declaration that "at some point the Federal Reserve will need to tighten financial conditions."
Anyone surprised by that statement hasn't been playing close attention. Bernanke has been prepping the financial markets for this eventuality for months.
While some market participants are worried about the Fed's eventual exit, Miller Tabak strategist Peter Boockvar, says the longer the Fed waits the worse it will be.
"The longer they keep the pedal to the meddle, the more disruptive the unwind will be," says Boockvar, who last November told Tech Ticker the Fed was wrong to keep rates at zero. "When you dig a deep hole, it takes a lot of climbing to get back out."
The Fed's exit strategy is somewhat technical, but includes raising the discount rate (the rate at which the Fed lends to banks) and increasing the rate the Fed pays banks on so-called excess reserves; the idea here is to entice banks to sit on the money vs. lend it out and could be viewed as another bailout, as Henry and I discussed Monday.
The good news is the Fed thinks the financial system is stable enough to even contemplate removing the "extraordinary degree" of stimulus put in place during the 2008 crisis and its aftermath. "These changes...should be viewed as further normalization of the Federal Reserve's lending facilities, in light of the improving conditions in financial markets," Bernanke testified.
The other news is that the Fed is in no hurry to rush for the exits; Bernanke reiterated a pledge to keep the fed funds rate abnormally low "for an extended period" and said the Fed has no plans to shrink its balance sheet by selling mortgage-backed securities or agency debt anytime soon.
Still, many observers wonder how the financial system and economy will react when rates eventually do exceed zero. "Put on your seat belt when all this begins," Boockvar quipped.
