Fed Watch: The Honeymoon is Over

Tim Duy interprets the latest Fed Speak:

The Honeymoon is Over, by Tim Duy: Note to Fed Chairman Ben Bernanke: Market participants do not need this kind of grief.  The financial wires are reporting versions of the following from the WSJ:

Stocks turned lower, though, in the final hour of trading after Maria Bartiromo, a commentator on financial news network CNBC, said Federal Reserve Chairman Ben Bernanke told her over the weekend that the media misinterpreted his comments in Congressional testimony last week as too lenient against inflation. Ms. Bartiromo said Mr. Bernanke told her that it was "worrisome" that the market would interpret his comments as too dovish.

Or, the quote from Bloomberg:

''I asked him whether the markets got it right after his Congressional testimony and he said, flatly, no,'' anchor Maria Bartiromo said. ''He said he and his Federal Open Market Committee members were basically trying to create some flexibility for the Federal Reserve, saying the Fed may pause but the data will really dictate whether more rate hikes will occur.''

Recall that Bernanke’s testimony last week was widely interpreted to imply that the FOMC is interested in pausing in the not so distant future, specifically identifying the possibility of pausing even if risks remain unbalanced. Apparently, Bernanke doesn’t like this interpretation of his comments, perhaps because it seemed to guarantee a pause at 5%. Instead, the FOMC wants flexibility, not guarantees. Which creates a whole lot of uncertainty for the rest of us.

Meanwhile, while the Dow was giving up its gains for the day and bonds were extending their losses, Atlanta Fed President Jack Guynn managed to sound like he wasn’t all that unhappy with the widely accepted interpretation of recent Fedspeak:

If - and I emphasize if - my most likely forecast of sustainable output growth and modest inflation is right, then I am of the view that we are very close to having Fed policy properly calibrated for now

Guynn appears to feel, that given the current flow of data, a pause is in the near future. Is he at odds with Bernanke? Or did he not get the memo from Bernanke that market participants had missed the mark last week? Or…?

I will stick largely to my previous interpretation of Fed policy. The FOMC would like the opportunity to pause; they do not want to keep blindly raising rates. They expect previous tightening to help pull the economy back to potential before inflationary pressures set in. The path of future policy depends upon their revisions of that forecast. If incoming data triggers a revision of that forecast, then the path of policy will change accordingly. No rate hikes are guaranteed. No pause is guaranteed either.

This all sounds good on paper. In practice, it is getting ugly. Bernanke is having a difficult time communicating policy. It is apparently difficult to determine the Fed’s interpretation of the incoming data. After all, Bernanke gave his testimony AFTER an unexpected jump in core CPI and a rise in oil prices to $75 a barrel. That would naturally lead one to take a dovish view of Bernanke’s comments. Indeed, even Guynn appears to have taken a dovish view.

If the FOMC in fact is reevaluating its inflation forecast for the back half of this year – and I wouldn’t blame them – they need to communicate that new information. Or, at the very least, do not reiterate the Guynn comments above.

Bottom line:  It looks like the Fed needs to work on its communication strategy. Interestingly, early reports on Bernanke praised his clarity compared to Greenspan. Doesn’t quite seem so clear today.

Update (MT): Link to Guynn speech: Nearing a Sustainable Balance of Economic Growth.
Update (MT): Video of Bartiromo's remarks. (Thanks CR, who comments here).

Update (MT) from Bloomberg:

Bernanke Gets a Crash Course in Leadership After Dinner Remark, Bloomberg: Federal Reserve Chairman Ben S. Bernanke is getting a crash course in what it means to be the head of the world's most powerful central bank.

Financial markets were blindsided yesterday after CNBC anchor Maria Bartiromo reported that Bernanke told her investors were wrong in thinking he's done lifting interest rates. ... It isn't clear exactly what Bernanke said; a Fed spokeswoman declined any comment. What is clear, Fed watchers say, is that Bernanke underestimated the scrutiny that anything he says, even in a social situation, will receive now that he's chairman.

''The management of communication here and the way things were said has, I think, undermined a little bit of Fed credibility for now.'' said John Ryding, chief U.S. economist at Bear Stearns Cos. in New York. ...

Richard Franulovich, a currency strategist at Westpac Banking Corp. in New York [said] ''Bernanke is still easing his way into the role and learning what he can and can't say, and to whom. He won't be speaking off the cuff to media people again. He's probably learned a lesson.'' ...

The report was unusual because most remarks by Fed chairmen are broadcast live by several television networks, delivered in speeches or in testimony to lawmakers, said Neal Soss, chief economist at Credit Suisse Holdings in New York, who once worked as an aide to former Fed Chairman Paul Volcker. Such events are generally scheduled at least a week in advance, allowing investors to prepare for them.

Bernanke isn't the first Fed chairman to learn the hard way that his words carry far greater import than before.

Shortly after taking over the reins at the Fed in August 1987, Alan Greenspan appeared on ABC's ''This Week with David Brinkley'' program and suggested that inflation could become a problem if consumers and companies thought that it was inevitable. Bond yields rose and stocks fell in response, and Greenspan never gave another television interview on the economy. ...

Comments

[calmo]

The market needs a 'yes' or a 'no' and Greenspan was polished at circumventing this need. Ben speaks with more clarity but the market, used to the convolution of Greenspeak, thinks they comprehend the relatively easy Benspeak and pronounce 'One and done'.
I don't envy him the spot. Atleast Greenspan has been seduced into silence these past few weeks...praise be to God.

[No Name]

Greenspan is busy writing his book, a great read that no one will understand ;)

As for the markets I think they are getting this idea that rates will either stop for good or that they will keep going up. The market needs to realize that they might pause, raise rates, pause, etc...

The market seems to think that pause = rates constant or down in the future. Dumb markets :)

[Tim Duy]

calmo - I think you have hit on a very good point. About a month ago I thought of writing a piece wondering if I was reading Bernanke as I would read Greenspan, and if that was not going to cause problems at some point. Hindsight is always 20-20.

What I realize bothers me even more is that Bernanke made these comments April 29, and Bartiromo didn't report them publically until the end of trading Monday. Did she tell anyone earlier....?

No name - what you are saying is correct. A one time pause does not mean done. A hike here and there, however, complicates life for traders.

Have I left the impression of one and done?

[anne]

This is simply media game playing and of no account. The Federal reserve is balancing slowing a strong economy just enough to limit inflation increases, and decisions will be made based on data to the day of Fed meetings. What has been happening in the market is simply a move by those who should have moved long ago to more defensive or international assets. I liten to the Fed chief only for thinking about economic issues, never for determining the direction of interest rates since the market will tell that in advance.

[anne]

Simply watch the movement of Vanguard's bond indexes to gain a proper sense of this Federal reserve cycle. Notice, now not the direction of the dollar as much as how Vanguard's European and Pacific and emerging markets stock indexes hold or fail to hold. Investors however should have moved assets abroad several years ago.

[Robert]

The markets are telling us - all of us - the Fed remains behind the curve despite Anne's protestations to the contrary - and that the markets aggregate wisdom expects that the FRB will remain behind the curve for the foreseeable future. This is made patently obvious by rampaging performance of all liquidity sensitive sectors (asset price-sensitive, commodities, energy, industrial demand-related, higher long rates, lower dollar, and recovery of financials) fueled by the continued gravitation towards negative real rates. Only the most interest rate-sensitive (Utils & REITs) whose exposure to growth is offset by sensitivity to rates, are failing.

The markets are telling everyone in crystal clear tone they do not believe FRB will curb demand sufficiently to dampen these trends, and that this will result in more of the same - i.e. galloping asset and commodity prices, continued acceleration in the real, experienced inflation rate with all their associated cascades, and investors are moving their chess pieces on the board accordingly. Whether or not this scenario has actual merit remains the subject of individual opinion and decision, for recall in 2002 the pendulum (and market positioning) swung heavily in favor of deflationary expectations, without experiencing it, the pressure which probably contributed to US near-ZIRP. But there should be no doubt of the markets current determination to continue to push in this direction until it hits a larger immovable force.

Watching this unfold with all the implicit macro and micro-impacts (and NOT acting decisively) will be hardest thing for a traditional balanced FRB to do, as the impacts and swings become more severe and volatile.

(And Anne, I am sure everyone would appreciate the wisdom of your "out-of-sample" forecast, rather than the "in-sample".;)

[anne]

Through this remarkable energy price increase and continuing robust growth, core inflation has been tame as the 2% rate through March shows. The Federal Reserve will easily be able to limit inflation from here, and if long term interest rates stay at the current moderate levels fair growth should continue. As for the dollar, investors who think ahead have been taking full advantage of international markets for several years. Last year the dollar gained about 15% against the Euro, this year the same may be lost. But, I find no reason to worry for the international economy appears remarkably or surprisingly healthy.

[Robert]

I respect your opinion, Anne, though I trust you will agree that it must be painful for a central banker to watch these telltales gallop away as they are. CRB Index was up 10% in last 30 days alone, and though I may agree with your opinion that "none of this is problemmatical" your/mine/our opinion becomes moot when the markets deem otherwise. For they [markets] are the ultimate arbiter of expectation, and the FRB ignores them at their peril. Also note that the "liquidity sensitive complex" running amok has exemplified high and reasonably stable co-movements amongst its so-called constituents that should/will further aggrieve interested observers such as the FRB. All a "Tempest in a teapot"? Maybe, but what stronger measures of directional expectations (of, for example, inflation and the future direction of asset prices, interest rates and the exhange value of the dollar) show the efficacy of the collective wisdom of markets?

[anne]

http://www.calvorn.com/gallery/photo.php?photo=6348&exhibition=7&u=99|1|...

Swamp Sparrow
New York City--Central Park, The Ravine.

You are always clevel :)

[Emmanuel]

Calmo, TD, and everyone,

What Bernanke needs to practice is what Yergin and Stanislaw called the central banker's mumble in "The Commanding Heights":

Volcker had perfected a talent for obfuscation and the central banker’s mumble, which mixed profundities and banalities and non-sequiturs in such a way as to be deliberately undecipherable.

Bernanke's desire to be plainspoken doesn't seem to fit with the job requirements; namely, of being constantly open to changing decision scenarios. Or maybe he was just overwhelmed by Maria's noted attractiveness and said something silly as men are prone to do. In any case, May 10 isn't far away.

[JS]

Calmo and Tim,
Good point about the shift from Greenspan’s ambiguity to Bernanke’s clarity. However, I think this is not just a communication problem, this is also an expectation problem. The fact that the market readily perceives Bernanke as a dove is not good, but not surprising. Essentially the market is looking for a green light to continue the excesses of the last 10 years. That means more run ups in asset prices, commodities, medical costs, tuitions, energy etc. (anything not manufactured with the benefit of global labor arbitrage is going to become very expensive, and eventually these things will bleed through to CPI and everyone knows it.) If Bernanke is serious about taking the punchbowl away, he’s going to have to change market expectations. The reason why we’ve been hearing from the “one and done” crowd ad nauseam is because the market expects pauses and easing. It doesn’t get much more obvious than that. That’s all the market has known as a general trend for the last 25 years with few and minor variations: pauses, easing and accommodation. Bernanke has taken over the Fed at a time when words like “pause”, “break” and “easing” are the last thing the market needs to hear or even think it hears. If he really wants normalized rates, regular risk premia and especially contained inflation expectations, he’s going to have to convince the markets that times have changed. If he is data dependent, he is going to have to prove it. It’s obvious and out there for everyone to see. He can either appear to be a dove and fall further behind the curve, or he can get tough. It’s said that new Fed Chairmen always quickly face a test. Bernanke is already facing his: the markets expect him to be accommodative regardless of data. The market has shown its hand, now we get to see Bernanke’s.

[Robert]

Thanks JS.

What you left out is that there is an emerging camp of inflation apologists who are keen to assert that it's not the fiscal gaps, and not the cheap money, and not ZIRP-bleed from Japan, but BRIC demand pull. Of course if it were just oil, copper & nickel, I might be more sympathetic to the argument, but the frenzy extends (as you point out) to domestic services, as well as any other non-outsourced service, or asset class from Manet's & rare manuscripts to Timberland, Orchards, or Lakefront real estate.

In hindsight, I would wager that given where Bernanke now sits, he regrets his helicopter speech irrespective of how reflective it is of his inner thoughts, for it makes his job of convincing the market of his even-handed that much harder having tipped his hand. His position is akin to that of a trader who a large line of stock to acquire, and knows his job is more difficult once he tips his hand. Sometimes in such a situation, you have to make small but meaningful sacrifices. For example, when some parasitic front-runners get wind of one's activity, one might turn around and aggressively sell half of what one has bought to metaphorically spank the parasites and keep them guessing, and thus insure they do not make the endeavor more difficult than need be. It might be more circuitious but it typically provides a more economical outcome. I fear that Mr Bernanke may need to make such a sacrifice, to fend off the moral hazard inherent in the current speculative market complex given his point of departure and his credibility which appears compromised.

[Mark Thoma]

Good comments. Tim will appreciate that.