That's how FT Alphaville begins their missive of comfort and joy:
Confused by the late, powerful rally on Wall Street overnight, that saw the Dow Jones Industrial close up 4 per cent?
Don’t be.
On one level, Federal Reserve chairman Ben Bernanke is targeting the stock market with the deliberately ambiguous statement that economic conditions “are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013″. (And it is Ben, not the FOMC, judging by that historic level of dissent.)
How so?
By keeping the Fed’s target rate at 0.00 per cent to 0.25 per cent for the next two years, he’s made holding stocks much more attractive. After all, anyone holding a 2-year Treasury will suffer a negative real rate of return, therefore will scramble for yield. RBS US rates strategist Eric Hiller put it this way right after the statement:
So, we know front-end yields are essentially anchored for 2-years and investors will scramble for yield and will compress all sorts of volatility measures and spreads. A month from now, we’ll all ponder why we waited so long to buy risk assets, buy the belly and sell rate volatility. Currencies can continue to gyrate and long-term rates aren’t anchored, but the 2-year note is gone, a function of deposit demand and cash withdrawals rather than policy expectations…Though there’s more to it possibly. There has to be! The Fed has signalled low rates forever already, practically.
Anyway, if you go back to Bernanke’s famed 2002 speech on how central banks can curb deflation, you get some familiar hints:
One approach, similar to an action taken in the past couple of years by the Bank of Japan, would be for the Fed to commit to holding the overnight rate at zero for some specified period. Because long-term interest rates represent averages of current and expected future short-term rates, plus a term premium, a commitment to keep short-term rates at zero for some time–if it were credible–would induce a decline in longer-term rates. A more direct method, which I personally prefer, would be for the Fed to begin announcing explicit ceilings for yields on longer-maturity Treasury debt (say, bonds maturing within the next two years). The Fed could enforce these interest-rate ceilings by committing to make unlimited purchases of securities up to two years from maturity at prices consistent with the targeted yields…Familiar but you can see how the logic of making it work, quickly leads to hitherto unimaginable ideas on reducing long-term rates....MORE
