If the consequences for the economy were less important one couldn’t help but be amused by the predicament in which Janet Yellen finds herself today. She and her fellow Fed travelers have been “preparing” the market for a rate hike for nearly a year and now it is that very preparation that has kept them from hiking rates as planned. As I’ve said numerous times recently, talking about changing monetary policy is the same as changing policy in that it produces exactly the same response. So, as the Fed talked about a rate hike, the market raised the value of the dollar as if the hike had already occurred. The rise in the dollar created concern about the ability of emerging markets to service their dollar debts which caused capital to flow out and back to the US which further raised the value of the dollar and increased the concern about emerging markets, the cycle continuing until the Fed was forced to postpone the rate hike due to “international developments” which were caused by the Fed’s efforts to prepare the market for the rate hike they just postponed.
Ben Bernanke started the trend toward Federal Reserve transparency in the belief that demystifying the process would lead to more efficient, effective policy. Markets would be forewarned about future changes in policy, adjustments would be made incrementally and the economy would function more smoothly. Yeah, maybe in a textbook but reality has been a bit different. Forward guidance – who came up with that stupid phrase; what other kind of guidance could they provide? – turns out to be nothing of the sort absent an operating crystal ball. When the economy doesn’t perform as the Fed expects – and when has it ever? – because the Fed’s transparency policy has changed the market conditions that were supportive of the outcome the Fed originally predicted, they are forced to change direction, to change their forward guidance – policy – rather abruptly which was what they were trying to avoid with forward guidance. It is a fresh, circular hell from which there is no exit (with a nod to Dorothy Parker and J.P. Sartre).
And so we are left to ponder the significance of Ms. Yellen’s speech last week which many took to be a walk back of the previous week’s uber-dovish FOMC statement which she also certainly had a hand in composing. Whiplash is not supposed to be a feature of the new market friendly Fed but keeping an eye and ear on all of them as they galavant about the country providing forward guidance willy nilly to one and all whether it is needed, wanted or counterproductive is a full time profession that requires an in house masseuse. One pines for the day when central bankers were seen and not heard.
Certainly Ms. Yellen’s speech, a stemwinder with 35 footnotes and a slide show that purported to show the rationale behind a rate hike, was a rhetorical shock to the cervical spine for anyone who saw her press conference the week before. One can’t help but wonder if the length of the speech and its plethora of citations, footnotes and graphs actually undermined its effectiveness. It appeared to be more an effort to convince herself and the other members of the FOMC that a hike was warranted than to sway the market. If you are going to play these psy-op mind games with monetary policy you better think it all the way through and consider the response to the response as well as the message sent by your rhetorical body language. Maybe the next Fed Chair should have a degree in psychology with a minor in game theory.
As Yellen tries to show confidence in the economy by talking up a rate hike while also trying to keep said rate hike from being reflected in markets – yet – the markets move ahead, usurping her authority over interest rates and sending its own signals. And the message isn’t that the economy is improving right now. Credit spreads continue to widen as the fracking companies’ hedges expire and they face the real consequences of $45 oil. Smaller wildcatters and companies that service the frackers will soon be meeting with a banker under pressure from regulators to reduce risk. Will the fracking bust be enough to cause a recession? I’ve said consistently and repeatedly that I don’t know and I still don’t. But the damage goes far and wide through the myriad companies that benefitted from the boom from sand companies in Wisconsin to well drillers to truckers and railroads.
Inflation expectations continue to fall and the long end of the Treasury curve outperforms as deflation fears linger even as Yellen frets about the Phillips Curve implications of full employment (as if more people working caused inflation; what a strange view of the world that is). Meanwhile, gold is outperforming stocks over the last three and six months, an indication not that Yellen is right about inflation but rather that her fears about global growth are likely warranted and the market is starting to price in a Fed response. Rather than preparing the market for a rate hike the Fed might find itself behind the curve in preparing it for another round of some kind of easing.
One thing that might work in the stock market’s favor, at least short term, is market sentiment which has turned quite, well, non-bullish lately. I guess 14 months of no price appreciation does tend to sour the mood a bit but I find it interesting that the category leading the pack is now neutral or some other variation on that theme. The bull camp has certainly been depleted but ex-bulls can’t seem to go all the way and admit to bearish tendencies, as if it were some kind of social stigma. What is the contrarian play when a plurality is neutral? Flip a coin? But the market is quite oversold and just about any news that is interpreted as bullish could produce a surprisingly strong rally.
If that stock rally does come, one would probably be wise to remember that not a lot has changed in the last few weeks through this correction. Stocks are still highly valued – and earnings are, at best, stagnant – credit spreads are still widening, the yield curve is still flattening and our long term momentum indicator is still on a sell signal; momentum is shifting to long term Treasuries and gold. Changing those things is not going to be easy and I doubt whether anything the Fed does or says will change them in the short term.
The Fed’s policy of forward guidance and radical transparency is not working. It turns out that letting the market peer over its shoulder as it makes monetary policy sausage is, in some ways, worse than the opaque process that existed prior to the arrival of Bernanke and Yellen. It pulls back the curtain and shows the human, error prone side of the Fed. Every time the Fed’s dots move, it is an admission of failure and undermines the very confidence it was trying to inspire. Yellen could probably learn a thing or two from a previous Fed Chairman:
I guess I should warn you, if I turn out to be particularly clear, you’ve probably misunderstood what I said.
She might also benefit from another quote from Pogo and remember that it was satire:
Having lost sight of our objectives, we redoubled our efforts.
Walt Kelly in the comic strip Pogo
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