The markets might be misreading the Federal Reserve’s messages.
“The FOMC was more hawkish than we had expected,” economists at Goldman Sachs concluded after the Wednesday Fed policy meeting, a view widely held on Wall Street trading floors.
However, a close look at Mr. Bernanke’s press conference comments and Fed official’s interest-rate projections released after the meeting show the Fed took several steps aimed at sending the opposite signal.
I am going to add two points. First is that while great pains were taken to lock up expectations of the path of short-run interest rates, the Fed may be underestimating the importance of the flow of asset purchases. Federal Reserve Chairman Ben Bernanke reiterated the Fed's belief that the stock of asset held is the key variable. Felix Salmon, however, has the oppostie view:
At his press conference yesterday, Ben Bernanke reiterated his view that the way QE works is through simple supply and demand: since the Fed is buying up fixed-income assets, that means fewer such assets to go round for everybody else, and therefore higher prices on those assets and lower yields generally. In reality, however, the flow always mattered more than the stock: when the Fed is in the market every day, buying up assets, that supports prices more than the fact that they’re sitting on a large balance sheet. And even more important is the bigger message sent by those purchases: that we’re in a world of highly heterodox monetary policy, where the world’s central banks can help send asset prices, especially in the fixed-income world, to levels they would never be able to reach unaided.
I tend to think that market participants generally favor this view. And why shouldn't they? The pace of the flow says something about the expected future stock of the assets. One way to interpret this week's events is that market participants now see that the stock of assets held by the Fed is reaching its peak, and while the Fed may not sell those assets, they will let them mature off the balance sheet.
The second point, which I don't think should be under-emphasized, is that only one person who was in the room Tuesday and Wednesday has spoken about the meeting - St. Louis Federal Reserve President James Bullard. And I think he gave a pretty clear message:
Policy actions should be undertaken to meet policy objectives, not calendar objectives.
The Fed shifted toward calendar objectives this week. It is the only way to reconcile Bernanke's plan for ending QE with the data flow.
More directly to the point, however, is Bullard's response in this interview with Neil Irwin and Ylan Mui:
N.I.: Is that correct? Is this a more hawkish Fed today than it was a week ago or a month ago?
J.B.: Based on Wednesday’s action, I would say it is.
Bullard was in the room and concluded the same thing markets concluded: The Fed shifted in a hawkish direction this week. Bernanke might have tried to cushion the blow, but you can't avoid the reality that he he laid out a plan to end QE - and that plan involves a shift toward a calendar component.