WASHINGTON – Just as Ben Bernanke prepares to turn the chairmanship of the Federal Reserve over to Janet Yellen, global markets are on edge over the prospect that she’ll extend a policy he began: a steady pullback in the Fed’s extraordinary economic stimulus.
Managing a slowdown in the Fed’s bond purchases without roiling markets will pose a tough early test for Yellen, who succeeds Bernanke as Fed chair next week. The Fed’s bond purchases have been intended to keep long-term loan rates low to spur spending and economic growth.
Investors have been nervous in part because a pullback in Fed bond buying will likely mean higher rates. Borrowing could weaken as a result. Many also fear that higher U.S. rates will lead some bond investors to move cash out of emerging markets and into the United States to seek higher returns. That fear has depressed currency values in emerging economies.
Once the Fed ends its meeting Wednesday, it’s expected to announce an additional $10 billion cut in its monthly bond purchases. Last month, the Fed said it would start reducing its monthly purchases from $85 billion to $75 billion. It decided to pull back mainly because of evidence the U.S. economy is strengthening and needs less support from the Fed.
Analysts expect the Fed to stick with that policy despite the turmoil in overseas markets, which has battered the currencies of Argentina, Turkey, Russia and other emerging economies. Those economies had previously enjoyed an inflow of investor money.
Now, those countries are having to deal with a reversal of those flows, said David Jones, chief economist at DMJ Advisors and the author of a new book on the Fed.
Jones see the market turbulence as a perfect illustration of the tricky transition that Yellen will have to manage as the Fed winds down the programs it put in place after the financial crisis erupted in 2008.
As long as they see a strengthening economy and sustained improvement in labor market conditions, they will continue to taper bond purchases, Jones predicted.
Bernanke will end his tumultuous eight-year tenure at the Fed amid tentative signs of a stronger U.S. economy. Employers created only 74,000 jobs in December, far below the 214,000 average of the previous four months. But many analysts think the lackluster December total marked a temporary pause or a statistical aberration.
The preponderance of evidence shows that the economy is continuing to recover, said David Wyss, an economics professor at Brown University and former Fed economist.
Since the recession ended in June 2009, economic growth has remained subpar. Analysts are forecasting a brighter 2014, in part because the federal government will impose less drag this year.