The WSJ’s inimitable Jon Hilsenrath has just published a note that emphasises that the market reaction to Bernanke’s tapering comments is inconsistent with how the Fed thinks the economy is likely to evolve.
Federal Reserve officials have been trying to convince investors for weeks not to overreact when the central bank starts pulling back on its $85 billion-per-month bond-buying program. An adjustment in the program won’t mean that it will end all at once, officials say, and even more importantly it won’t mean that the Fed is anywhere near raising short-term interest rates.
Hilsenrath then goes on to survey the various money market instruments that suggest that the Fed will tighten some time soon, and notes that this is inconsistent with the Fed’s stated policy rule — given that most forecasters do not the unemployment test to be met for some time.
Since last December the Fed has been promising to keep short-term interest rates near zero until the jobless rate reaches 6.5%, as long as inflation doesn’t take off. Most forecasters don’t see the jobless rate reaching that threshold until mid-2015.
The market can stay irrational longer than you can stay liquid … still! The effort has been a total communication failure — totally counter-productive.
According to the Atlanta Fed, the spike in real yields, and collapse in break evens has pushed market based measure of deflation probability to the highest level in three quarters. For the Fed, that’s a total fail …
At the same time, however, the Fed is talking about pulling back on its $85 billion-per-month bond-buying program. The chatter about pulling back the bond program has pushed up a wide range of interest rates and appears to have investors second-guessing the Fed’s broader commitment to keeping rates low.
This is exactly what the Fed doesn’t want. Officials see bond buying as added fuel they are providing to a limp economy. Once the economy is strong enough to live without the added fuel, they still expect to keep rates low to ensure the economy keeps moving forward.
It’s a point Chairman Ben Bernanke has sought to emphasize before. The Fed, he said in his March press conference and again at testimony to Congress last month, expects a “considerable” amount of time to pass between ending the bond-buying program and raising short-term rates.
He seems likely to press that point at his press conference next week, given that the markets are telling him they don’t believe it.
Ben wants higher equity prices, a weaker USD, and lower rates — so that he doesn’t get deflation.
Help a Chairman out, won’t you? Buy him some SPX, AUD, and eurodollars … maybe receive some 2x5x10