FOMC teaches a lesson

IFR 2075 21 March 2015 to 27 March 2015
6 min read

THE MUCH-ANTICIPATED FOMC meeting has been and gone and, truth be told, I think we learnt more about ourselves than we did about the Fed.

Watching Fed chair Janet Yellen in the run-up to the meeting made me think of the satirical puppet show here in the UK in the 1980s and 1990s called Spitting Image. It brilliantly poked fun at all and sundry in public life and not having a puppet made of oneself meant, in certain circles, that one had not made an impact.

When John Major came to power as prime minister ­– the successor to Margaret Thatcher – he was depicted as a grey man with a grey face, grey hair, grey suit and over all grey demeanour. If the modelling team had to make a puppet for Fed chair Janet Yellen, it might be created along similar lines.

Until last week at least, Dr Yellen had not grabbed the markets by the soft bits and shaken them until they understood what she was trying to say. Thus, instead of hanging on her every word ahead of the meeting, market participants try to pre-empt or second guess her. That trillions of investment dollars should have been dancing on a pinhead the size of an eight-letter word – patience – worries me.

What will last, I hope, is the lesson that the Fed is no longer given to spoon-feeding the markets

IN TRUTH, AND despite the post-FOMC comments that “economic growth has moderated somewhat”, the domestic US picture is still pretty positive. Growth is broadly good, unemployment is close to the sustainable target of 5.5% and the time has surely come to unwind one of Ben Bernanke’s last “unconventional measures” – the zero interest rate policy.

Pressure has certainly been rising to begin to normalise the interest rate structure.

One thing is clear, though: it cannot afford to move too early. Central banks are often accused of being “behind the curve”. In a tightening cycle that does not exist. In the same way in which shooters are taught that no bird can fly faster than the hunter can swing the gun, so no economy can shoot ahead faster than the central bank can tighten, if it so desires.

What it does not want to do is to make the same mistake that the Bank of Japan made in the early 1990s, which was to begin to tighten too soon. At the time, the BoJ seems to have hoped that by tightening it could create the impression that recovery was stronger than it really was. Markets were briefly spoofed but the real economy wasn’t and what has followed has been two lost decades. This proves that the risks are of moving too soon and too fast, not the other way around. Once the first move has been made, there is no going back.

The last Fed tightening was in June 2006. Realistically, nobody who is trading markets and is under the age of 30 has ever seen the Fed raise rates. They have been made to fear tightening as though it meant the end of the world. It doesn’t. What ZIRP has done, though, is to foster an unhealthy lack of respect for risk and some near-religious belief that the bail-out of troubled risk assets is just one FOMC meeting away.

Nowhere in the Fed’s remit is there any word about it having responsibility for supporting markets. It has its well documented dual role with respect to growth and inflation but what the markets are up to is essentially their business. That said, the Fed does use the markets as barometer of what the outside world thinks of its overall policy but that’s about it. (The problem with Alan Greenspan was that he liked it when the markets liked what he did and so he ended up with a reputation – maybe right, maybe wrong – for tailoring monetary policy to the markets.)

IN THE EVENT, the FOMC caught the Street napping. The latter was so obsessed with “patience” that Dr Yellen‘s totally cool and dispassionate explanation that removing patience from its statement did not indicate that it was impatient took many millions of highly paid IQ points totally by surprise.

Wednesday’s knee-jerk reaction to buy stocks and bonds and to sell the dollar – the spike in dollar/euro up to US$1.10 certainly triggered a few painful stop-losses – didn’t last, but what will last, I hope, is the lesson that the Fed is no longer given to spoon-feeding the markets.

Markets have become complacent and have continued to believe that central banks and their monetary policy decisions are principally here for their benefit. Dr Yellen may be grey and boring and the least charismatic Fed President in many years – being less charismatic than Ben Bernanke takes quite some doing – but that does not mean she’s stupid.

The decision to make policy data-dependent buries forward guidance ­– in my view not a minute too soon – but also shows that she and her Merry Men are not being dovish for dovishness sake but that they will not be pushed into a tightening cycle simply because that is what the market expects. In that, they are ahead of the game and the Street had better get its skates on if it wants to catch up.

Anthony Peters