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Fed's Mixed Signals On Continued QE Roil Stocks, Bonds

The central bank dropped more hints Wednesday it could taper monetary stimulus in the not-too-distant future but remained vague about the timing, giving it more policy flexibility for now.

Fed Chairman Ben Bernanke told Congress that while easy-money policies are helping home prices, stocks, auto sales, manufacturing, jobs, consumer demand and price stability, now is not the time to start pulling back.

"A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further," he warned.

But a few hours later, minutes from the Fed's last policy meeting showed "a number" of participants are willing to trim monthly bond purchases, or quantitative easing, as soon as June.

Prewithdrawal Jitters

Stocks sold off hard after rallying earlier on Bernanke's testimony. Treasury yields also spiked.

The markets' sharp reversal — and negative reaction when the Fed paused after the first two rounds of QE — show why policymakers will want to tread carefully in reducing stimulus.

Bernanke also told Congress that the Fed could start to scale back QE purchases of $85 billion a month "in the next few meetings" if the labor market outlook keeps strengthening. When asked if that means tapering could begin before Labor Day, he replied, "I don't know.

New York Fed President William Dudley told Bloomberg TV he's not sure when the economy will rebound enough from tighter fiscal policy to justify less QE, but expects to find out in "three or four months.

Central bankers are sending mixed signals because the economy is still mixed, said Steve Blitz, chief economist at ITG Investment Research.

He pointed to the Fed meeting minutes, which revealed doubts about whether stronger consumption could be sustained without more business investment and hiring as well as worries over federal spending cuts and low labor force participation.

While policymakers still see moderate economic growth, they noted weakness in manufacturing, inflation and exports.

"They're not quite ready yet to start moving toward the end game," Blitz said, doubting that QE will be scaled back in June.

If anything, the minutes suggest that the Fed's views on maintaining QE are more balanced vs. the prior weight toward scaling it back, he said.

Passing The Baton

In addition to waiting for substantial job market improvement to trim QE, Bernanke may be waiting for other central banks to buy more assets, said Jack Ablin, chief investment officer of BMO Private Bank in Chicago.

"He's trying to figure out a way to pull back stimulus and potentially pass the baton to other central bankers," he said.

QE's financial market stability risks are not a big Fed worry yet. Bernanke said concerns have risen "a bit," but added the Fed is looking for any signs of a bubble and noted a weak economy can also worsen financial stability.

In response to a senator's fears about lower junk bond yields and soaring asset prices, Bernanke said, "There's no risk-free strategy here.

Separate reports showed April sales of existing homes rose and that the Fed-fueled housing recovery boosted earnings for builder Toll Bros. (TOL) and home improvement retailer Lowe's (LOW).