Alan Greenspan, chairman of the Federal Reserve from 1987 to 2006, prided himself on his ability to obfuscate. And justifiably so: The headlines after his semi-annual testimony to Congress didn't just disagree over a nuance, they often had an entirely different take on what Greenspan said, not to mention the implications for future interest rates.
Ben Bernanke, the current Fed chairman, is no Alan Greenspan. He has flung the communication door wide open -- too open, some say. With the benchmark interest rate fixed at 0 to 0.25 percent for 4 1/2 years, "forward guidance" -- or, as I call it, talk therapy -- has become one of two major policy tools. (The other is large-scale asset purchases, or quantitative easing.)
Bernanke thinks it's important to communicate clearly in order to guide expectations. The Fed wants long-term interest rates to stay low? Then give the markets a clear trajectory for short-term rates.
Financial markets know that at some point, QE has to taper and end. Short-term rates will have to rise. Bernanke seems to think he can smooth the process by preparing markets and guiding them through each step. He doesn't want to jeopardize the recovery with a sharp rise in long-term rates. (Don't tell anyone, but a steeper yield curve is actually expansionary.) It may work, but if the economy were to take off, the Fed would find itself hopelessly behind the curve, with the funds rate well below anything close to a neutral level.
Scanning today's headlines, I can only imagine the transparent Bernanke's reaction.
Associated Press: "Bernanke Signals Fed to Maintain Stimulus Efforts"
New York Times: "Fed Endorses Stimulus, but Message Is Garbled"
Washington Post: "Fed's Mixed Message Takes Stocks on a Wild Ride"
Wall Street Journal: "The Fed Sends Stocks Higher -- Then Lower"
CNBC: "What to Make of Bernanke's Testimony?"
As yesterday wore on, with the Dow Jones Industrial Average turning a 115-point gain into an 80-point loss, what Bernanke said was filtered through the prism of the market's reaction. And when the losses stateside spilled over to Asia and Europe, well, Bernanke clearly must have said something very, very bad. The minutes from the Fed's April 30-May 1 meeting, released at 2 p.m., took on a life of their own amid the sell-off. My reading: Policy makers had a lot more "concerns" about the economy than confidence in it.
To be sure, markets are forward-looking. Yet in an environment where the Fed is pegging the short-rate and sucking up the lion's share of the Treasury's new issuance, it's a losing proposition to get too far ahead of the Fed. I would still put greater odds on the Fed overstaying its welcome than in aborting QE too soon.
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