The Annotated Hilsenrath
In a weekend dominated by discussion of the "Taper Tantrum", i.e., interpretations of what Hilsenrath "said" after the close on Friday, what the Fed wanted him to say, what the market's response to what he said or did not say would be, and what the next steps may be, we present this convenient annotation of Hilsenrath's complete recital courtesy of Mike O'Rourke from Jones Trading.
The WSJ’s Jon Hilsenrath published a story Friday evening titled “Fed Maps Exit From Stimulus - Timing of Wind-Down Is Uncertain, but Focus Is on Managing Unpredictable Market Expectations.” We suspect the twitter taper caper on Thursday opened the window for the FOMC to provide some clarity as to where policy stands. Here are some key questions. Is this story important? Can it be taken at face value and should markets move? The answer is yes, yes and yes. The WSJ placed the article prominently on the cover of the Saturday edition, so they believe they have an important story. It is a Hilsenrath story, and in the post-recession QE era the Fed has used him to foreshadow almost every major monetary policy move. Finally, in a tape where QE is the dominant theme, any indication of policy slowing or reversing course is meaningful.
We think the headline in and of itself is interesting “… Focus Is on Managing Unpredictable Market Expectations.” Are market expectations really highly unpredictable? Has this Fed done anything done but promise excessive monetary support for the US economy? The market only expects what the Federal Reserve has conditioned it to expect. Nearly every time the stock market dipped over the past 3 years, a new asset purchase program was launched. We view “unpredictable market expectations” as a sign that the FOMC has been trying to foreshadow policy in one direction and the market is interpreting it in another direction.
Since this story is important, we decided to share our thoughts that came to mind as we read through it and have quoted the text of the original article below. You can skip to our key takeaways in parentheses and blue text at the end of the paragraphs.
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“Federal Reserve officials have mapped out a strategy for winding down an unprecedented $85 billion-a-month bond-buying program meant to spur the economy—an effort to preserve flexibility and manage highly unpredictable market expectations.”
(The Fed has done little to dissuade the market from believing it can or will meaningfully reverse course on monetary policy. Despite the Fed Chairman’s championship of transparency at the Central Bank, he chooses to foreshadow hawkish policy through the WSJ or the FOMC minutes rather than having to make a speech and own the statements himself. This is his way of keeping his flexibility. Our question is this - if your formal speeches and statements primarily advocate easier monetary policy and all indications in the other direction come from surrogates, are the market expectations really that unpredictable?)
“Officials say they plan to reduce the amount of bonds they buy in careful and potentially halting steps, varying their purchases as their confidence about the job market and inflation evolves. The timing on when to start is still being debated.”
(“Halting steps”- that is an interesting description. On one level it sounds abrupt, but it more likely means there could be pauses between moves.)
“The Fed's strategy for how and when to wind down the program is of intense interest in financial markets. While the strategy being debated leaves the Fed plenty of flexibility, it might not be the clear and steady path markets expect based on past experience.”
(This gives the indication that investors will prepare for the FOMC meeting by trying to anticipate if the FOMC will trim $10 or $20 Billion this meeting. Similar to a decade ago when the looming question was whether the FOMC would move 25 or 50 basis points or make no move at all.)
“Officials are focusing on clarifying the strategy so markets don't overreact about their next moves. For example, officials want to avoid creating expectations that their retreat will be a steady, uniform process like their approach from 2003 to 2006, when they raised short-term interest rates in a series of quarter-percentage-point increments over 17 straight policy meetings.”
(Finally, some type of acknowledgement of what a disaster that policy was. This new approach should lead to lead to mildly more volatility. This is a healthy development. The added uncertainty should help keep the market honest by reducing some low conviction speculative activity.)
"I don't want to go from wild turkey to cold turkey," Richard Fisher, President of the Federal Reserve Bank of Dallas, said in an interview Friday. "I think we ought to dial it back." Mr. Fisher is part of a contingent of Fed hawks who are wary of the Central Bank's easy-money policies.
(Despite being one of the Fed Presidents with a logical constructive view, if Ben Bernanke does not listen to Fisher then why should we.)
“Stocks and bond markets have taken off since the Fed announced in September that it would ramp up the bond-buying program, and major indexes closed at another record Friday. An abrupt or surprising end to it could send stocks and bonds in the other direction, but a delayed end could allow markets to overheat. And some officials feel they've ended other programs too soon and don't want to repeat the mistake.”
(In 2010, St. Louis Fed President Bullard practically begged Bernanke to keep QE1 open as a dormant but ongoing policy allowing for additional purchases if the economy weakened and sales if it strengthened – similar to the manner in which the Fed funds rate policy is administered. Bernanke chose to let QE1 sunset. Then 2 ½ years later the Chairman adopted Bullard’s approach. These days President Bullard is leaning to the hawkish side.)
“The Fed's strategy on how to unwind the program has emerged as a source of some uncertainty in markets in the wake of its policy meeting earlier this month. The Fed said in its post meeting statement that it was ‘prepared to increase or reduce the pace of its purchases’ as the economic outlook evolved.”
(This balanced language in the FOMC statement was met with new stock market highs. We noted that considering the soft round of economic data, the word “reduce” was a surprising hawkish twist to us. It is very possible and now it is looking likely that it was meant to be hawkish. A hawkish jawbone met with more speculative activity could be an example of the “highly unpredictable market expectations.”)
“The suggestion that the Fed might boost its bond buying was a change in the policy statement that appeared to some as an acknowledgment that more aid for the economy might be needed. Employment data in April was weak and inflation has fallen well below the Fed's 2% inflation objective, both points that allow leeway for more stimulus.”
(The Congressional authority for the dual mandate reads as follows "effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” Up until last year, the unofficial inflation target of 2% annual PCE growth was used to make sure inflation stayed in check. We understand the deflationary risks in the economy, but this thinking that if inflation is below 2% the FOMC needs to do more is dangerous, and essentially contrived. This is not an exercise of the authority given to them by Congress. Unless the FOMC is prepared to tighten at 3% (we were approaching it in 2011), it should not be pushing for additional easing at 1% as Chicago Fed President Evans does daily.)
“But many officials believe the recovery is on track and aren't yet concerned about the inflation slowdown. Instead, the most recent statement seems more aimed at signaling the Fed's broader flexibility in managing the programs.”
Charles Plosser, president of the Philadelphia Fed, said in an interview Friday that the change in the statement was meant "to remind everybody" that the Fed has "a dial that can move either way."
(Just like President Fisher, President Plosser has constructive views, but for anyone with hawkish views their credibility among market participants has been undermined by the Bernanke, Yellen & Dudley block.)
“The dial can also pause. Fed officials could shrink the size of their purchases and hold it at that level for a while as they assess the effects, or they could make several moves in a row if that seemed right. They could also boost their buying if they lose confidence about the economic outlook. The strategy is meant in part to ensure flexibility in an uncertain economy.”
(The market will only believe the dial can move in the other direction when it actually happens.)
“Yet while officials appear increasingly settled on a strategy for how to dial back the program, they haven't decided when to start.”
(In 2009-2010, Chairman Bernanke gave speeches on the “exit strategy.” Since then, he has alluded that it might not go according to the original plan. So it’s no surprise that the lack of further details on timing falls deaf on market ears.)
“Mr. Fisher said he advocated starting right away at the last Fed meeting. Some officials can envision taking a first step this summer, if strong data shows the economy is weathering the tax increases and federal spending cuts that appear to be weighing on growth. But they might wait longer, especially if the economy disappoints, as it has for several years during the spring and summer months.”
(Yes, the seasonal adjustments. Three years into recovery the Fed has finally figured it out. )
“A Wall Street Journal survey of private economists this week showed that 55% expect the Fed to start shrinking its bond purchases in the third or fourth quarter this year, while 45% expect the Fed to wait until next year or later. None expected the Fed to increase its purchases as its next step.”
(After this article, 100% should expect tapering to start this year, but they won’t.)
“The bond-buying programs are aimed at pushing down long-term interest rates and boosting financial markets to encourage more borrowing, spending and hiring in the broader economy. The Fed's securities holdings have increased from $2.58 Trillion to $3.04 Trillion since September.”
(That’s just change in Chairman Bernanke’s couch cushions).
“Clearer signals about the Fed's plans could emerge next week. Five regional Fed bank presidents, including Mr. Fisher and Mr. Plosser, and Fed governor Sarah Bloom Raskin are scheduled to speak. Fed Chairman Ben Bernanke will discuss economic prospects for the long-run in a commencement address at Bard College at Simon's Rock next Saturday.”
(Chairman Bernanke just spoke by way of this article. If anyone outside of Bernanke, Yellin or Dudley speaks, nobody will listen. NY Fed President Dudley has a speech May 21st. More importantly, Chairman Bernanke testifies on the economic outlook in front of the Joint Economic Committee on May 22nd. )
"Central bank officials want to see substantial improvements in the job-market outlook before the programs are ended all together. And then, efforts to boost short-term interest rates might not occur for months or even years later.”
(The “considerable period of time” mentioned at the last press conference.)
“The unemployment rate has fallen to 7.5% from 8.1% since August, both because of hiring and people leaving the workforce. Payroll employment has increased on average by 193,000 per month during the eight months since the program was launched, compared with average gains of 157,000 before it began. "It is pretty hard to say we haven't seen an improvement in the labor market," Mr. Plosser said.
(The average Unemployment Rate for the last 20 years is 6%, the last 40 years is 6.5%. No matter how much of a rush you are in to get somewhere, you still don’t drive 80 miles per hour in the driveway.)
“Many economists believe economic growth will slow in the second quarter—in part because of fiscal drags—from a 2.5% annualized rate in the first quarter, but then accelerate in the second half. If growth remains firm in the weeks ahead that could give officials more confidence about starting to pull back.
Fed officials aren't very concerned about the annual rate of inflation falling toward 1% in recent months, well below their 2% objective. Because expectations of future inflation have remained steady, many Fed officials expect inflation readings to move back up toward 2% in the second half of the year. ‘I'm not too worried about it,’ Mr. Plosser said. ‘Expectations remain pretty stable.’"
(This was addressed above, Plosser is right. We have to reiterate the FOMC manufactured a new target and it has become the justification/rationalization for policy beyond its mandate.)
“The Fed has policy meetings in June, July and September, and Mr. Bernanke will have a chance to explain its actions at news conferences in June and September.”
(June makes a lot of sense to get the process rolling and start managing those unpredictable market expectations.)
“Some of the bond-buying program's most vocal proponents have signaled more optimism about the outlook and a willingness to consider pulling back from the programs. John Williams, president of the Federal Reserve Bank of San Francisco, said in an interview last month that he anticipated pulling back this summer.”
"I'm looking for continuing signs of improvement in the economy," he said, "sustained, ongoing improvement in the economy."
(Aren’t we all?)
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