Since equity markets made their May highs and Fed Chairman Ben Bernanke made those comments about the risks of holding interest rates too low for too long, markets have been on a roller coaster ride as investors mull the possibility that the Fed is looking to pare back its current stimulus measures in the coming months. Despite the fact that Mr Bernanke reiterated that the Fed had no plans to wind down the current levels of bond purchases and that interest rates would stay close to zero for a “considerable time” markets chose to focus on the more negative aspects of the Chairman’s comments. It could be argued that in trying to adopt an evenly balanced response to questions by saying that there was scope to expand the scheme as well as taper it back, his comments about reducing stimulus “in the next few meetings” if the data warranted, had the unintended consequences of raising the prospect, however remote, that some form of tapering could happen before the year end. It seems that certain market participants took this to mean that the Fed would somehow be minded to stop the current stimulus program abruptly which prompted a sharp bout of profit taking on some of the hefty gains seen so far this year. This seems quite a leap from concerns about a gradual reduction of stimulus if the data warrants it, and it would appear that far from criticisms that the Fed needs to work on its communications strategy it could be argued that the market needs to work on its listening strategy. This month’s FOMC meeting has been widely heralded as one of the most important meetings in years which seems to be attaching an importance to it that it scarcely deserves, however such is the market schizophrenia at the moment Mr Bernanke would appear to have his work cut out in trying to placate market concerns that an orderly exit strategy is in place. He is likely to be pressed for a timeline on any potential tapering measures, however given that any such strategy is likely to be data dependant it is likely to be quite difficult to be able to put any time line on such a strategy, and even if the current $85bn a month is pared back the Fed will still be adding to the monetary base at the rate of billions of US dollars a month. Of more importance is the Feds outlook for the US economy which is currently slightly more optimistic about growth prospects than the IMF, World Bank and OECD’s outlook, and this could give clues to the timing of any tapering, especially if they leave their forecasts unchanged which would suggest that any early reduction of stimulus could happen sooner rather than later. At best the markets will be looking for reassurance from Mr Bernanke that the Fed intends to keep rates low for some time to come and that it will be looking to manage any form of reduction of stimulus measures in a very gradual and orderly manner in a fashion that takes into account the state of the US economy. Of course the market has to decide whether or not it wants to listen to Mr Bernanke’s words and that is another matter entirely. The Fed is quite likely to taper in the coming months, and the only unknown is over the timing, but given the current mixed data the prospect still seems several months away. The current market response can probably be best summarised in the following manner. Three months ago the prospect of an end to open ended stimulus wasn’t even on the radar of investors as markets hit multi-year highs, and by raising the prospect of curtailing the Fed’s current measures Bernanke has changed that mind-set and in so doing has undermined the idea of the “Bernanke put” as it is known and raised the prospect that for all people’s perceptions about QE, it does have a limited shelf life. It is hard to see how Mr Bernanke will be able to change that perception tomorrow, which means the current volatility could well continue throughout the summer. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person