There is a terrific post by Barry Ritholtz at The Big Picture, “What is the Fed Really Thinking?” which was also picked up by Brad DeLong as an excellent example of Fed-watching.
Barry pointed out last week that the latest FOMC report clearly indicated stagflation. He later noted that the market’s peppy response to the report was a bit daft, because with the Fed signalling a greater likelihood of rate cuts, the Fed wasn’t proposing to cut rates for the good reason that the risk of inflation was lowering. No, it said that cuts would be in the offing if the economy got worse. That isn’t exactly good news for stocks.
Now Ritholtz argues (convincingly) that someone at the Fed called Greg Ip at the Wall Street Journal to tell him what the FOMC report meant, and Greg Ip dutifully wrote that up. And the market dutifully went down.
That begs the question, Why does is the Fed going to so much trouble to be understood? In a bit of synchronicity, another DeLong post today quotes Greenpan as saying in 1987:
Since I have become a central banker I have learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said…
Now one could simply attribute the Fed’s concern the misinterpretation of its latest report as a manifestation of Bernanke’s new policy of greater transparency. But calling the Journal, rather than waiting for one of the routine appearances of Bernanke or a Fed governor, seems to suggest they felt it awfully important to get the information out, and in a way it would be heard.
So what does that suggest to me? That the Fed didn’t like the market rally of last week.
That may seem a very strange idea (you’d normally expect the Fed to invervene in markets only to stem potentially damaging downward movements), but hear me out. First, back on May 8, 2000, the Journal ran a first page story about Greenspan’s interest in stock prices (as in the general level thereof, not stock picking) and was devoting considerable Fed economist resources to that task. That struck me as bizarre and worrisome, because the stock markets aren’t the Fed’s job.
Second, we have Greenspan talking about recession in Hong Kong, which appears to have contributed to the worldwide market decline of Feb. 27. Bernanke had a scheduled appearance before the House Banking Committee the next day, where he said reassuring things and the markets calmed down. Greenspan backed off a bit, but kept muttering about recession.
Now many observers thought that Greenspan was making Bernanke’s job difficult, but we suspected this could actually be a loosely-coordinated “good cop -bad cop” act, that Bernanke either wants or expects the market to go down for reasons known only to his army of Fed economists (like all that leverage and those non-existant risk premia for risky assets are going to end up badly) and he is trying to take the markets down gently. Thus, the clarification of the last FOMC report is part of this pattern, trying to let the air out of the bubble as gently as possible. Otherwise, why not let the market participants figure out, which they will in upcoming weeks and months, that they misread the Fed and react badly later? Perhaps Bernanke & Co. was concerned that if investors reacted later, the reaction would be more extreme.
And as Fed chairman, given the unknown but possibly very ugly impacton hedge funds (which are very big credit market particants) of a rapid fall in the markets, it might be argued to be within his purview to influence market prices (in a way, it’s the only way he can manage the solvency and safety of fiduciaries he does not oversee). We had people in a position to know tell us that if the meltdown of the Feb. 27th had progressed much further that week, there would have been enough margin calls to lead to more selling, and serious damange to a lot of hedge funds. And if enough hedge funds got hurt, the prime brokers wouldn’t be far behind.
So we think it may not be crazy to believe that the Fed is trying to manage not simply market perceptions, but even market prices.
And the fact that they are going to these lengths says they may indeed be concerned about systemic risk if certain scenaraios play out. Otherwise, calling the Journal to staunch a wee bit of optimism in the markets seems like overkill.
To Ritholtz:
Last week’s rally was ignited by a simple change of phrasing in the FOMC statement. Market took that to mean not only that increases are off the table, but — Hallelujah! — a rate cut is in the offing.
Not so fast.
Whenever the Fed says or does something that is subsequently misinterpreted, they have a few back door methods to correct the error. Two in particular were used fairly regularly. Call it the Fed edit/correction methodology.
When John Berry was at the Washington Post, he could be discretely contacted. He’s now the Fed columnist at Bloomberg, and while I’m sure he maintains his FOMC contacts, we haven’t seen him “break news” like his WaPo days. He primarily does analysis, and he is very insightful as to what the the Fed is thinking. That’s quite valuable, but its not the same as “getting the call.”
These days, that takes place with the WSJ’s Greg Ip. And in a page one article, he lays out what the news is from on high:
“When the Federal Reserve last week altered its post-meeting policy statement to soften the suggestion that it might raise interest rates, Wall Street was confused.
Was the Fed signaling that a rate increase was less likely because the outlook for the economy had darkened? Or was it simply reflecting the reality that interest rates are on hold for now?
The answer to both questions is, yes.”
With no one quoted, and no speech is cited, one has to assume this is straight from the horse’s mouth. The WSJ doesn’t print factual statements about the Fed on the front page without knowing this is precisely what they are thinking. That’s simply not how they roll.
So we can assume that Mr. Ip. is repeating what he was told by very senior Fed Sources. Consider the specifics of the following:
“The Fed is seeing increased risks to its forecast that the nation’s economy will grow moderately this year. Those risks include the surprisingly weak level of business investment and the hard-to-predict outcome of the current troubles at the riskier end of the mortgage market.
The Fed changed its statement last week to get the flexibility to cut interest rates in coming months if those risks grow. But it is unlikely to use that flexibility anytime soon, because the risks aren’t big enough and inflation remains uncomfortably high. (emphasis added)
I’ll bet you that the last underlined sentence came verbatim from the Fed. If it was not emailed, than it was spoken slowly and repeated. And the surprisingly weak CapEx chart? Yeah, you can assume that has the Fed nervous.
Here’s another classic insider line (and the word “Housekeeping” is classic bureaucracy speak):
“Housekeeping” played a part, as well. For several months, some officials saw the Fed’s previous policy statement, which had indicated rates could rise but not fall, as increasingly inconsistent with their own expectations of unchanged rates for the foreseeable future.
We are only to the middle of the article, and we get the conclusion:
The new statement reflects a Fed on hold. It contains no explicit reference to the direction of rates, saying only that “future policy adjustments will depend” on growth and inflation, but reiterates enough inflation concern to indicate lower rates aren’t on the table.
The rest of the piece is worth a read, but after this point its just a standard article.
Update: We’ll have a test of my possibly paranoid views. I had not realized that Bernanke was testifying before the Joint Economic Committee of Congress, as described in the FT, “Bernanke set to clarify Fed stance:”
Ben Bernanke will be under intense scrutiny on Wednesday when he testifies before the Joint Economic Committee of Congress – a week to the day after the Federal Reserve surprised the markets by adopting a confusing new policy statement.
At the time, the markets thought the Fed was signalling that its next move would be a rate cut; a week later, the market has substantially reversed its view.
The Fed chairman is likely to have to clarify what the new statement means. He might also be pressed to reveal where he stands on an emerging argument inside the Fed as to what its inflation objective should be.
Bernanke proved himself eminently capable of talking the markets up when he wants to, ss he did on February 28. We will see if he “clarifies” the Fed’s position (which as Ritholtz pointed out per above, was downbeat on the prospects both for growth and for inflation, even though no one seemed to want to hear that) or decides to fudge. The latter would prove my theory above to be wrong.
