Bernanke sets course for easing up on stimulus

Paul Davidson | USA TODAY

WASHINGTON — Federal Reserve Chairman Ben Bernanke for the first time laid out a likely road map Wednesday for winding down the central bank's unprecedented stimulus policies starting later this year, sending the stock and bond markets reeling.

At a news conference after a two-day Fed meeting, Bernanke said that if the economy and job market continue to improve, the Fed could begin "later this year" to scale back its $85 billion a month in government bond purchases that have juiced the economy and stock market. The Fed could continue to trim them until they're halted by mid-2014.

Bernanke suggested that a key guidepost for the Fed is whether the current 7.6% jobless rate falls to 7% by this time next year.

Financial markets that were rattled on May 22 after Bernanke said tapering could begin "in a few meetings" were shaken further by his more detailed blueprint, which raised fears about whether economic growth might slow with less Fed support. The Dow Jones industrial average fell 206 points to 15,112. Ten-year Treasury yields rose to 2.31% from 2.18%.

The Fed said it's keeping its stimulus at full throttle for now. It will continue to buy $85 billion a month in Treasuries and mortgage-backed securities until the labor market improves substantially. The purchases hold down long-term interest rates and have fueled the housing rebound and a blazing stock rally.

Bernanke emphasized that if the economy and job market falter, Fed policymakers could stop dialing back the bond-buying and even increase it again. He said that by tapering the purchases, the Fed is still adding stimulus to the economy — just at a reduced level. He compared the action to "letting up a bit on the gas pedal as the car picks up speed, not to beginning to apply the brakes."

The good news for bond investors may be that markets have largely built in a rise in interest rates into prices. If the Fed begins to rein in the purchases as early as its September meeting, as many economists now expect, 10-year Treasury yields could rise initially toward 2.75% but then decline as investors shift money from stocks to bonds, says LPL Financial market strategist Anthony Valeri. Rates on many consumer and business loans, which are tied to the 10-year Treasury yield, could follow the same path.

The Fed's willingness to pare its stimulus is based on its more bullish economic outlook. Its statement said "downside risks" to the economy have "diminished since the fall." Bernanke said federal spending cuts are reducing growth, but added that they're offset by a housing rebound.

The Fed now expects the 7.6% unemployment rate to fall to 7.2% to 7.3% by year's end and to 6.5% to 6.8% by the end of 2014.