One has to pity Ben Bernanke during the remainder of his tenure as head of the Federal Reserve, which is due to terminate in January 2014. For his bold experimentation with unorthodox monetary policy has not worked out quite the way he had anticipated. And this puts him in a position where he has an unenviable policy choice to make in the sense that he will be damned if he exits QE3 too quickly and damned if he does not.
The Fed’s open-ended decision in September 2012 to buy US$85 billion a month in US Treasury bonds and mortgage backed securities has led to the mother of all US asset price rallies. Since September 2012, the US equity market has rallied by more than 20% despite lackluster corporate earnings results. At the same time, yields on US high-yield bonds have plummeted to record lows of barely 3%, while US 10-year Treasury bonds now still yield less than 2% despite the country’s challenged fiscal position. This has to raise the question as to whether Bernanke’s monetary policy largesse has not created asset price bubbles and whether it has not caused financial markets to take on excessive risk.
While asset markets appear to be on fire, the same might not be said of the US economy. The economy is limping along at barely 2% growth, which leaves unemployment stuck at around 7.5% and which leaves an army of discouraged workers who remain outside the labor market. Meanwhile, there is the real prospect that the US economy might slow further under the full weight of tax increases and public spending cuts resulting from the compromise to avoid the fiscal cliff and from the public spending sequester.
In the months ahead, Mr. Bernanke will have to make the hardest of policy choices. Does he continue with QE3 unchanged in its present form and risk further inflating asset price bubbles, which will pose even greater risks to the US economy when QE3 is eventually unwound down the road? Or does he begin scaling back on QE3 now and risk a relapse in a US economy that might not yet be quite ready for the withdrawal of extraordinary monetary policy stimulus? This might all explain why Mr. Bernanke is reportedly not interested in serving another term as Fed chairman.