Scratching Their Heads, Investors Start Revising Expectations for the Fed

For investors, it’s back to the drawing board.

Wall Street is now furiously revising expectations about the role the Federal Reserve will play in the economy in the months ahead.

The bout of introspection comes after the Fed dashed the widespread assumption that it would begin slowing down, or “tapering,” its $85 billion-a-month bond buying program — a stimulus effort that has become a driving force in financial markets.

Over the summer, a number of speeches by the leaders of regional Fed banks were watched carefully and interpreted as supporting a slowing of bond purchases. Many on Wall Street said that in the future, they would pay less attention to flurries of public statements and reconsider the barometers they were using to predict Fed decisions.

“From May forward, the body English suggested that they were ready to taper,” said Ken Taubes, the chief investment officer at Pioneer Investments. “Now the moral of the story is, ‘Don’t look at what we’re saying.’ ”

Until the Fed’s surprise announcement on Wednesday, investors had spent months preparing for a slowdown in the Fed’s bond purchases by selling off, buying dollars and getting out of countries that relied on low interest rates. On Thursday, investors were buying some of those same assets back, sending up stock indexes 4.6 percent in Indonesia, 3.5 percent in India and 2.3 percent in Pakistan.

In the United States, the signals were more mixed, pointing to uncertainty created by the Fed’s decision. The stock market reversed some of the big gains it made in the final hours of trading on Wednesday.

After climbing 1 percent on Wednesday afternoon, the Dow Jones industrial average slipped Thursday by 40.39 points, or 0.3 percent, to close at 15,636.55. The Standard & Poor’s 500-stock index dipped 3.18 points, or 0.2 percent, to 1,722.34. The Nasdaq composite index, however, edged up 5.74 points, or 0.2 percent, to 3,789.38.

The yield on Treasury bonds, which dropped sharply on Wednesday, rebounded somewhat, with the rate on the benchmark 10-year bond rising to 2.75 percent from 2.69 percent late Wednesday, pushing the price down 16/32, to 97 27/32.

Many investors realized on Thursday morning that the Fed would not give up on slowing its bond purchases, but instead was only pushing the date out.

Ben S. Bernanke, the Fed chairman, said on Wednesday that if measures of inflation and unemployment improved, “we’ll take the first step at some point, possibly later this year, and then continue so long as the data are consistent with that continuing progress.”

Julia Coronado, an economist at BNP Paribas who correctly predicted the Fed’s move on Wednesday, said she still expected the taper to begin as soon as December, given the numerous signs that the recovery is slowly picking up speed.

“The decision wasn’t made in fear — they just want to make sure we get more momentum under our belts,” Ms. Coronado said.

But even pushing the next steps out just a few months adds a good dose of uncertainty to the process. Some strategists said that if Mr. Bernanke steps down as Fed chairman at the end of the year, as is widely expected, his successor could have more room to reconsider any slowdown in stimulus.

Moreover, some believe that Mr. Bernanke would be hesitant to make such a big change in policy just a month before leaving the job.

“Frankly, it’s set off an awful lot of questions about what’s going on, who’s in charge and what’s happening,” said Robert F. Baur, the chief global economist at Principal Global Investors. “I’m not sure the market really knows what to think.”

Mr. Bernanke emphasized that part of the reason for the pessimism within the Fed was the return of political fighting in Washington over the federal budget. That is likely to have Wall Street carefully watching the debate in the coming weeks about whether to raise the debt ceiling. But that factor was already on the radar of most economists and accounted for in their forecasts.

The most significant shift in investor thinking is likely to focus on economic data, which Mr. Bernanke said was the primary factor driving the Fed’s decision-making.

In the past, many investors focused on Mr. Bernanke’s comments in June, when he suggested that the Fed would closely watch for unemployment to fall to 7 percent. This week, Mr. Bernanke played down the importance of the headline unemployment figure, saying it was often an imprecise measure of the job market.

Ms. Coronado, for her part, said she would now pay more attention to the total number of jobs the economy added each month rather than the unemployment rate hitting the 7 percent mark. She noted that the Fed had appeared to be optimistic about the labor market earlier this year when more than 200,000 new jobs were being created each month. More recently, the monthly jobs figure has fallen below that threshold.

Many strategists also took note of Mr. Bernanke’s particular emphasis on the low level of inflation, which he said he would like to see increase.

Another major concern for the Fed was the recent jump in interest rates, and with it the rise in mortgage rates, which put a damper on the previously buoyant housing market.

Strategists at Bank of America, who predicted Wednesday’s action, said on Thursday that they did not think the Fed would slow down its bond buying until the housing market could sustain a rise in interest rates. Specifically, Bank of America’s experts said they were waiting for a time when new mortgage applications would continue to rise even with higher mortgage rates.

“The summer reversal in housing activity was a likely signal to the Fed that the macro is still too fragile to withstand even a small tapering,” the Bank of America team wrote in a note to clients.

The latest economic data suggested that the recovery may be staging the sort of acceleration that the Fed wants to see. The number of homes sold in August rose to the highest level in six years, despite predictions that the number would fall, according to figures from the National Association of Realtors.

And an index of manufacturing activity released by the Philadelphia Federal Reserve experienced a sharp jump this month, showing that the pace of growth had more than doubled.

The data was enough to revive speculation about the Fed beginning its tapering sometime this year. But most strategists said that the recent difficulty in predicting the Fed’s actions would probably stop many on Wall Street from quickly jumping to any conclusions.

“There’s going to be a little more uncertainty about what the Fed’s intentions are and what the future holds,” said Mr. Baur. “That uncertainty is going to keep people nervous.”