By standing pat, Fed's Bernanke leaves successor with no map

successor will inherit both the massive balance sheet and series of policy promises that stretch ahead for years

Federal Reserve Chairman Ben Bernanke's shock announcement on Wednesday that the US central bank was not ready to pare back its stimulus program could make it more difficult for his successor to navigate the Fed's way out of its extraordinarily aggressive policy.

Economists had expected Bernanke to follow through with the rough chart he had drafted in June: trimming the Fed's bond-buying program before year-end and ending it by mid-2014, when he expected the unemployment rate to be around 7%.

On Wednesday, however, he said only that tapering the purchases could "possibly" begin later this year and that there was no "magic number" for unemployment to mark its end.

Delaying a reduction in the Fed's $85 billion-a-month bond-buying will likely make only a small impact on the overall size of Fed's balance sheet, now at $3.6 trillion and counting. But it injects a huge amount of uncertainty into the equation, and leaves Bernanke's successor without a useful roadmap.

"Part of the reason I thought the Fed was committing to some type of tapering was because they wanted to set a course, to make it more difficult for (Bernanke's) successor to deviate from it," said Eric Stein, a portfolio manager for Eaton Vance.

He said the Fed now risked further misalignments between its intentions and financial market expectations, particularly given that a new chairman is expected to be at the helm by February 1. "I do think it will be harder because markets do misjudge."

Bernanke's second term atop the world's most influential central bank ends in January and President Barack Obama has made clear he is searching for a successor, with Fed Vice Chair Janet Yellen now the front-runner for the job. An announcement could come as soon as next week.

Even if Bernanke announces a reduction in the bond buying at the next Fed meeting in October, he will likely be a weakened "lame duck."

Whoever succeeds him will inherit both the massive balance sheet and a series of policy promises that stretch ahead for years. He or she will also need to contend with the disappointing economic recovery and stubbornly high jobless rate four-and-a-half years after the recession ended.

"It does leave a bigger job for the next chairman," said Scott Anderson, an economist at Bank of the West in San Francisco. "I think there's a good chance that the Fed hasn't even started the taper when the new chairman comes in."

Of course, by standing pat this week, Bernanke has likely also given the new chairman more leeway in charting a course for a group of Fed policymakers that could include several new members. Fed Governor Sarah Raskin has been nominated for a top US Treasury job and Elizabeth Duke stepped down last month.

Among the decisions ahead: when to start reducing asset purchases, how quickly to wind them down, and whether to trim purchases of Treasuries or mortgage-backed securities first. In addition, the new chair importantly will need to assure markets that cutting bond purchases does not mean the Fed is close to raising interest rates.

To Randall Kroszner, who served under Bernanke on the Fed Board during the financial crisis, the chairman actually did his successor a favor by testing the market's reactions to potential changes in the bond-buying program, first in May by raising the prospect that a tapering of the purchases could come soon and then again on Wednesday by holding off on any changes.

A selloff in US Treasury bonds began in May and gained momentum through the summer, with emerging-market currencies following suit, as investors prepared for a lessening of the Fed's stimulus. That all reversed abruptly on Wednesday.

"It really has made it much easier for whoever might become chair on February 1," Kroszner said.

Missed opportunity

Many investors thought the time was ripe for the beginning of the end of aggressive Fed support for the economy.

The US unemployment rate fell to a four-year low of 7.3% last month from 8.1% a year ago; the latest reading on GDP growth was better than expected; and the likelihood of US military intervention in Syria has receded, erasing another cloud of economic uncertainty.

But a sharp rise in interest rates - propelled by Bernanke's own statement in May that the Fed hoped to pare bond-buying in the "next few meetings" - cast doubt on the sustainability of the economy's momentum, prompting the central bank to maintain its current policy.

The unexpected decision pushed market expectations of a first official rate hike into 2015, where most Fed officials also see it. The central bank has kept short-term interest rates near zero since December 2008.

Economists who thought they saw the writing on the wall for a reduction in the bond purchases this month are now reassessing; many at top Wall Street firms now predict the Fed won't trim them until December, but a substantial minority have not yet decided.

"We're quite surprised the Fed didn't take its opportunity now to scale back its purchases," said Credit Suisse economist Dana Saporta. The inaction, she said, "may complicate the transition to the next chair in the sense that it leads to more uncertainty among market participants."

Bernanke dismissed the idea he was leaving adrift the next generation of policymakers on the Fed's Federal Open Market Committee. "I don't think that we are complicating anything for future FOMCs," he told reporters on Wednesday.

Others believe that the Fed's underlying commitment to boosting employment and stabilizing inflation will mean broad consistency even after the transition.

"Obviously, whoever the next chairman is has a tough job, but I don't see a big departure from current policy," said Glenn Hubbard, a former chairman of the White House Council of Economic Advisers under President George W. Bush and now dean of the Columbia University Graduate School of Business.

Now that Bernanke has left himself so little time to start to winding down the bond buying, investors could start to pay more attention to Yellen. She gives a high-profile speech in New York on October 1.

Several observers thought that the more dovish Fed that emerged from Wednesday's meeting showed Bernanke's employment-focused deputy was already taking a stronger hand in shaping monetary policy. Earlier this year she urged the Fed to put the goal of reducing unemployment at "center stage."