LONDON (Reuters) - Like a father who has told his son the tooth fairy does not exist, Ben Bernanke must find a way to soothe investors who feel betrayed since he told them it was also a fantasy to hope he might keep printing free money for ever more.
Financial markets, of course, knew deep down that the Federal Reserve would have to start withdrawing its extraordinary monetary stimulus once the U.S. economy was out of the emergency ward.
But bond yields have climbed and share prices have sagged globally since the Fed chairman shocked investors on May 22 by saying the bank might ‘take a step down’ in the pace of bond purchases in coming months.
Bernanke has the opportunity to recalibrate expectations when he briefs the media on Wednesday after a two-day meeting of the central bank’s policy-making panel.
The Fed chief cannot disavow last month’s remarks. But, given the scale of the subsequent asset-market selloff, he is expected to indicate that the economy is still too poorly to justify slowing the pace of bond buying, now $85 billion a month, right away.
And as for raising interest rates from near zero, that day remains distant.
“The confusion since May 22 will force them to make clarity a high priority at this upcoming meeting,” said Ward McCarthy, chief financial economist at Jefferies in New York.
To that end, McCarthy speculated that the Fed might map out its base-case starting date for reducing bond buying along with a preliminary schedule of the wind-down, subject to the usual caveats on growth, inflation and financial markets.
“The problem is they can’t use a light switch. They have to have discretion because nobody knows what the future bears, so they will never give up their flexibility - and nor should they,” he said.
Manufacturing surveys from New York and Philadelphia due this week, as well as a national poll of homebuilders, are unlikely to suggest the need for a swift tapering of the Fed’s accommodative stance.
McCarthy reckons the economy is expanding at a pace of about 2 percent, but that might falter unless inventory accumulation picks up.
Indeed, many economists expect the Fed to nudge down its central forecasts for 2013 growth and inflation.
“All in all, conditions for a self-sustaining recovery are not yet in place,” said Douglas Roberts, an economist with Standard Life in Edinburgh. “If anything, weak inflationary pressures are giving the Fed a clear mandate to focus on getting economic growth up and running again.”
The tightening in financial conditions represented by lower share prices and higher bond yields is an additional headwind for a global economy still growing well below trend due to the after effects of the great financial crisis.
But leaders of the Group of Eight major powers, meeting in Northern Ireland on Monday and Tuesday, can be expected to try to bolster confidence by accentuating the positive.
The G8 communiqué was likely to reflect a “somewhat better situation in the global economy” than the year before, according to a senior European official.
Somewhat is the operative word. Data provider Markit’s purchasing managers’ index (PMI) for China on Thursday is likely to provide further evidence of a slowdown in the world’s second-largest economy.
The euro zone’s PMI is expected to have edged higher in June but will still point to shrinking output in the 17-country bloc zone, which has been in recession for the past six quarters.
“The pace of deterioration has declined. That’s the best thing that can be said,” according to Jens Larsen, chief European economist at Royal Bank of Canada in London.
Recent indicators were consistent with a modest recovery in either the third or fourth quarter, he said.
“It’s not a lot more than that. I’m not particularly confident about the euro area. Equally, I feel more comfortable that the euro area is not heading south at a pretty fast rate and the chances of a large-scale monetary response from the ECB are now pretty small,” Larsen said.
Additional reporting by Luke Baker in Brussels; Editing by Susan Fenton