Markets sway back and forth to Bernanke's beat

NEW YORK — Given his prior government service and impressive academic background, there was little reason to think the audience most pleased with Ben Bernanke's early tenure leading the Federal Reserve would be short-term traders who thrive on volatility.

Yet that group probably loves Bernanke. In the past 10 days especially, the U.S. stock market has been a Bernanke market. It has swung widely and somewhat irrationally on the Fed chief's public comments about inflation, supplemented at times by the remarks of Bernanke's colleagues.

The impact of those comments has also been felt by stock markets around the world, as well as fixed-income and commodities markets.

Market participants Thursday decided to lift the self-imposed gloom that has prevailed since June 5, when Bernanke said inflation increases represented "unwelcome developments" that would be confronted.

To investors, that meant more rate increases and slower economic and corporate-profit growth. Not good for stocks.

Yet the scenario was never that simple. In the glass-half-full view, a vigilant Fed is exactly what is needed to secure equity valuations. The economy is in fact growing and would likely not get knocked off track by one, two or even three more short-term rate increases.

On Thursday, Bernanke observed, among other things, what was plain to any student of market rates. Market-based inflation expectations implied by nominal and inflation-indexed yields have fallen back somewhat in the past month.

Inflation expectations "bear watching" and energy prices are likely to stay high for some time, Bernanke said. But stock traders focused on the positive.

After rising more than 110 points Wednesday, the Dow Jones industrial average climbed nearly 200 points Thursday and closed back above 11,000.

It's true markets overshoot and undershoot, which is the reason individual investors are so often advised to chart a long-term investment path and ignore the "noise" created by those who can profit from short-term volatility. Still, recent market behavior, presumably in large part reacting to Bernanke, seems overdone.

The Fed should and will raise the federal-funds rate when it meets June 28-29, pushing the rate to 5.25 percent. Moves after that will depend on data and on market reactions to data, so there's an element of self-fulfilling prophesy.

One solution to market volatility would be to urge Bernanke to talk less. Short-term traders thrive on developments, no matter how transitory, to create liquidity and volatility, and Bernanke has been a reliable supplier of news.

But that's shortsighted. Sure, there's an element of Bernanke learning on the job and recognizing the absurdly large power of his words at certain times in market cycles.

It is also true that this is a complicated time, with a long and mostly automatic tightening process coming to an end. It's a time that tightening is starting to slow growth to more sustainable levels, but a time when threats that inflation will stay unacceptably high persist.

On a facile level, it would seem Bernanke has been all over the place in his remarks of recent weeks. But he hasn't. He has spoken clearly and often about the complex situation faced by the Fed.

There have been missteps by Bernanke, to be sure. But the intention to communicate with markets and the public is a good one and shouldn't be discouraged. Even if volatility addicts seem to be among the major beneficiaries.

Neal Lipschutz is vice president and managing editor of Dow Jones Newswires. Brian Blackstone contributed reporting to this column.