Posted by 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.
Got that?
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
ricardian ambivalence 
every central banker around the world wants the same however… who will win is hard to know!! euro doller higher? the US economy seems in better shape. Yen higher ? no…. AUD higher ? maybe, but RBA is cutting rates too and we seem to be at the peak here in Australia. Hopefully the economy in th US will surprise even the fed this winter.
one thing quite likely: buy stocks when things have calmed down.
Eurodollars are short term interest rate futures.
Ha, thought you meant EUR/USD!
The Chairman wants higher equity prices, higher bond prices and lower USD, without getting involved?
I think this is him getting involved :)
No, that’s not the problem. The problem is that any tapering – let alone a cessation of bond purchases – is a tightening of policy and that’s not what the US economy needs right now. Suggesting that no bond purchases and zero rates represents a neutral stance is a mistake.
Good point. Isn’t bond purchases even more important than the level of rates itself? Who’s going to buy bonds at these low yields / high prices if not supported by the fed ad infinitum? Not me.
However nothing last forever and markets do know. There will be a point when the US economy finally ignites, fed WILL taper and we will have more of what we have seen in the last few weeks. By then, the economy hopefully will be strong enough and will be shielded from market volatility. Yes, I expect Bernanke to be super-dovish next week (who doesn’t expect that?), but then there’s September and December, etc. And if this is working properly then it has to stop sooner or later, unless it’s NOT working, which would be a bigger problem anyway.
Sure: totally agree. The fed has this stock idea and the market a flow idea – so a pull back creates a fuss. You could reconcile the two by saying that the mkt expected a longer period of 85bn/m, and the shortening is tightening…
Regardless, the market is clearly telling the Fed they were hasty.
Ricardo, how does Hilsenrath manage to have such superior access to the Fed’s (Bernanke’s) thinking? That sort of thing has been controversial here. Given the sums of money at stake, why isn’t there more of a fuss?
No idea … He claims he just speaks to all the votes and make a judgement. Awesome track record …
Rajat, it isn’t tightening just less expansionary ( There is a difference) however if the economy is expanding appropriately then that is what is desirable