It might be a close race to decide which day of the month is the silliest, the Friday of the “jobs” report or the FOMC meeting (which are two-day events, but only the second day seems to count; and the FOMC meets every six weeks or so which means the Establishment Survey has a few months all to its self). That being said (and properly qualified), this meeting may be more decrepit than typical and not because QE is expected to be voted out.
There is an undercurrent of monetary policy shifting that I don’t sense has been appreciated by either markets, observers or even most economists that usually parrot the Fed word for word. This is not to say that there is more “hawkish” sentiment now, not at all. Instead, it is the manner in which “dovishness” is being expressed and how it might be carried out in the future.
This process is far more evident in foreign central bank programs of late, Bank of Japan aside (or maybe not?). The PBOC and ECB have made a clear choice to start more “focused” and “targeted” means of expressing monetary “stimulus.” The Fed itself in ending QE seems to be opting for the opposite, but that only acts as a rejection of Beranke-isms rather than a shift away from these new foreign actions toward actual market forces.
When Janet Yellen first moved into Bernanke’s office, there had already been a significant modification in views on QE. This relates to the full adoption of secular stagnation, as no longer was QE seen as a tool to “nudge” the economy back to its prior path of potential. Instead, the FOMC has come to view QE as almost fully ineffective in that task, but rather blaming the economy than the financialism. Because “there is something wrong with the economy”, as this view leads, QE can only have negative side effects (bubbles) without much gain.
The other major tool that Bernanke introduced alongside QE3 was “forward guidance.” I have seen many people try to explain forward guidance, but few seem to grasp what it really means (including, as always, economists). Standing in Bernanke’s shoes in September 2012, there was a bit of a conundrum about QE3 (and then QE4 a few months later). One of the main “channels” of QE psychology was longer term interest rates, which was where QE sought to gain the most influence (having exhausted the usual channels through equally ineffective ZIRP).
However, if QE was effective in its psychology, long term rates would rise in anticipation of actual recovery and “inflation.” This would be particularly “noisy” in the belly of the curve where the intersection of inflation and growth expectations runs into the finance mechanics of QE. So Bernanke had to essentially “invent” a means by which to disable that very natural market impulse so as not to have longer term rates defeat QE right from the start. Enter “forward guidance.”
Essentially, Bernanke manipulated the financial factors to override the “market’s” desire to discount information. By establishing an unemployment threshold, then 6.5%, he could use the “market’s” desire to scalp profits by frontrunning actual QE operations against itself. Therefore, the primary consideration would be placed on QE-buying rather than the eventual success of QE in the economy and toward “inflation.” I think there is no doubt this was expressed in credit markets, especially TIPS and inflation breakevens during that fourteen month period where they went “dark.”
Interest rates would thereby reflect policy not reality; a system built upon monetarism rather than fundamental discounting.
The problem is that the economy has not lived up to expectations, assertion and all proclamations, and now the “market” is reasserting itself in the “wrong” direction (all except the good, slavish rationalizations in stocks). The problem for Yellen’s Fed is that though QE never met its actual goals (again, secular stagnation) “forward guidance” has really handcuffed the FOMC by attaching these “guideposts” in the unemployment rate and whatever they have turned to recently to “loose” or “tight” policy stances.
Before becoming Vice Chairman of the Fed, in September 2013 Stanley Fischer was quoted by the Wall Street Journal expressing grave doubts about “forward guidance.”
“You can’t expect the Fed to spell out what it’s going to do,” Mr. Fischer said. “Why? Because it doesn’t know.”
He added: “We don’t know what we’ll be doing a year from now. It’s a mistake to try and get too precise.”
Mr. Fischer said he tried, on becoming governor of the Bank of Israel in 2005, to give signals to the market – but quickly gave up as he realized it restricted the bank’s future actions when circumstances changed.
“If you give too much forward guidance you do take away flexibility,” said Mr. Fischer.
A year later, accompanying September 2014’s FOMC meeting, the FOMC issued a statement seeking to “clarify” “forward guidance”:
At their September 2014 meeting, Federal Reserve policymakers indicated that, in determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, they will assess progress–both realized and expected–toward their objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
This is not clarification at all, but rather a blatant misdirection to remove forward guidance by saying it is really something far less distinct. Literal “forward guidance”, as Bernanke used it, would mean stating actual guideposts. This new definition is the exact opposite, removing any and all given “guidance.”
In short, Bernanke-isms are no more at the FOMC; “forward guidance” had ended last month, and today QE3 and QE4 will likely follow. This won’t be repeated in the mainstream conversation, but the FOMC has repudiated everything that Bernanke implemented as both ineffective and, at least what they would admit in policy terms, far too restrictive.
But the real message is how it is restrictive, which is something I expressed some months ago. “Forward guidance” is only a problem if you “need” to go back to expressing “loose” policy once more. In other words, if the economy were actually on solid ground there would be no need to discard “forward guidance” since the path would be quite solid. This is further complicated by “markets” that are attached far more to the financial aspects, as Bernanke intended, than to fundamental expressions of confidence in monetary success.
“They” can never admit any of this publicly as that would lead directly to disorder in both finance and economy. However, given the setup and the means and expressions that got us here, they may never have to admit it as “markets” are starting to see through the fog of obfuscation (which is what “forward guidance” always was) to the woman behind the curtain. After all, it is actual market behavior that has them so worried at the moment, where credit markets are now “somehow” far less affected by more promises of further misdirection and cajole (except, again, stocks).
Maybe Bernanke felt boxed in at the time, particularly as the slowdown in the economy was real and probably terrifying for his FOMC, but none of this should be surprising. Like almost everything that has been tried in the post-crisis period, “forward guidance” as well as QE were done in Japan first, except in the opposite order. The Bank of Japan switched to “forward guidance” in 1999 to accompany the world’s first ZIRP. They said then that they would keep interest rates at zero until “deflation” was ended, standing by it still today for all the “good” it has done.
Putting Bernanke’s programs out to pasture is not the same as having an epiphany about financialism, but it may yet represent progress. In the past, as with the sorry state of Japan, central banks never found theoretical recriminations after empirical disqualification, always instead doubling down in each and every instance. This time, as expressed not just by the Fed but, again, the PBOC and ECB, maybe central bankers have started to realize cause and effect, monetarism and bubbles, and have extrapolated and projected what that may mean after a third collapse. In other words, the emphasis now is not just on bubbles, which were heretofore never even admitted, but on serial bubbles. Unfortunately, if taken literally, true forward guidance today would be an unmistakable and direct message to stock investors to actually take note of all this as a warning.