Sometimes, the hardest thing to do is nothing... and this week's FOMC decision will be among the hardest The Fed has faced in months - do they once again give stocks exactly what they are demanding, teaching the spoiled child once again that if they scream enough, they'll get their juicebox; or remain "patient", reminding stock speculators that risk is real, that uncertainty demands a premium, and that bonds might just be on to something.
Former fund manager and FX trader Richard Breslow appears to be in the latter camp, suggesting that the FOMC won't do anyone any good at all by doing anything this week.
Everybody wants to be loved. Which makes distinguishing between what the FOMC is likely to do this week and what they should do unusually difficult. They will most likely hope to get away with staking out a middle ground. Promise flexibility and agility without making any firm promises. And the market will just have to live with that. But they won’t be happy. Fixed-income markets are flexing their muscles and want the Fed to bend to their will. It’s a temptation that should be resisted.
This is no environment where even short-term forecasts carry a lot of weight. And policy makers shouldn’t spend their sparse resources in order to satisfy futures traders who are trying to prove that they are the boss. Should it come to pass that a rate cut is warranted, there will be no difficulty in getting the message out and pulling the trigger. It’s beyond ludicrous that there remains a need to be constantly reassured that the Committee is watching things carefully and stands ready to act.
The concept of an insurance cut isn’t appropriate. It wouldn’t do any good anyway. One and done won’t satisfy anyone and would be economically meaningless. The examples cited from the 1990s have always struck me as not applying. Either on the basis of the restrictive rates or rapidly tightening financial conditions that characterized both instances. Back then, the market needed the psychological boost, the payments mechanism required some greasing and the banks had their hands out. None of that applies now.
You can’t understand the 1995 episode without reference to the rapid and, to resolutely and inexplicably stubborn traders, disastrous tightening of 1994. And this wasn’t an example of the U.S. being an outlier. Take a look at a Short-Sterling or Bankers’ Acceptance chart to get a sense of what was going on globally.
The post-LTCM/Russian default cut was in reaction to hard news that sent markets reeling. There was nothing proactive about it. They didn’t have dots to confuse the issue. Although, it further solidified the notion that the Fed stood perpetually ready to paper over the mistakes of others. And employing over-leverage was a viable strategy.
Inflation expectations remaining low is also a poor excuse to pull the trigger now. It’s certainly not fresh news. Nor will it change by lopping 25, or even 50 basis points, that we can’t afford off of the Fed Funds rate sometime this summer. It may be sacrilege to say so, but the 5yr/5yr measure is merely a financial-market construct that gets too much attention. Where traders are setting this price can change on a dime. Tell me where crude oil will be trading five years from now and guessing where forward inflation swaps will be gets a lot easier.
There is a wide expectation that the word “patient” will be removed from the communique. It’s a shame, because that is exactly what they should be telling the market. The Fed may indeed be central banker to all but going off message to achieve some financial-condition peace is misguided. And it won’t help Europe or Asia either.