August 10, 2016, 4:00pm EST
After the past two weeks, that included a Fed decision, more BOJ action, the approval of Japanese fiscal stimulus, a rate cut and the return to QE for the Bank of England, and a strong jobs report, this week is a relative snoozer.
With that, every headline this week seems to contain the word Trump. Clearly the media thought a post by the former Fed Chairman, the architect of the global economic recovery and interventionist strategies that continue to dictate the stability of the global economy (and world, in general) today, wasn’t quite as important as Trump watching.
On Monday, Ben Bernanke wrote a blog post that laid out what appears to be his interpretation of a shift in gears for the Fed – an important message. Don’t forget, this is also the guy that may have the most intimate knowledge of where the world has been over the past decade, what it’s vulnerable to, and what the probable outcomes look like for the global economy. And he’s advising one of the biggest hedge funds in the world, the biggest bond fund in the world and one of the most important central banks in the world (at the moment), the Bank of Japan. And it’s safe to assume he still has influence plenty of influence at the Fed.
My takeaway from his post: The Fed’s forward guidance of the past two years has led to a tightening in financial conditions, which has led to weaker growth, lower market interest rates and lower inflation.
Why? Because people have responded to the Fed’s many, many promises of a higher interest rate environment, by pulling in the reins somewhat.
To step back a bit, while still in the midst of its third round of QE, the Fed determined in 2012, under Bernanke’s watch, that words (i.e. perception manipulation) had been as effective, if not more, than actual QE. In Europe, the ECB had proven that idea by warding off a bond market attack and looming defaults in Spain and Italy, and a collapse of the euro, by simply making promises and threats. With that in mind, and with the successful record of Bernanke’s verbal intervention along the way, the Fed ultimately abandoned QE in favor of “forward guidance.” That was the overtly stated gameplan by the Fed. Underpin confidence by telling people we are here, ready to act to ensure the recovery won’t run off of the rails — no more shock events.
The “forward guidance” game was working well until the Fed, under Yellen, started moving the goal posts. They gave a target on unemployment as a signal that the Fed would keep rates ultra low for quite some time. But the unemployment rate hit a lot sooner than they expected. They didn’t hike and they removed the target. Then they telegraphed their first rate hike for September of last year. Global markets then stirred on fears about China’s currency moves, and the Fed balked on its first rate move.
By the time they finally moved in December of last year, the market was already questioning the Fed’s confidence in the robustness of the U.S. economy, and with the first rate hike, the yield curve was flattening. The flattening of the yield curve (money moving out of short term Treasuries and into longer term Treasuries, instead of riskier assets) is a predictor of recession and an indicator that the market is betting the Fed made/is making a mistake.
And then consider the Fed’s economic projections that include the committee’s forecasts on interest rates. By showing the market/the world an expectation that rates will be dramatically higher in the coming months, quarters and years, Bernanke argued in his post that this “guidance” has had the opposite of the desired effect — it’s softened the economy.
So in recent months, starting back in March, the Fed began dramatically dialing back on the levels and speed they had been projecting for rates. It’s all beginning to look like the Fed should show the world they are positioned to well underestimate the outlook, rather than overestimate it, as it’s implied by Bernanke. The thought? Perhaps that can lead to the desired effect of better growth, hotter inflation.
This post by Bernanke is reversing some of the expectations that had been set in the market for a September or December rate hike by the Fed. And the U.S. 10-year yield has, again, fallen back — from 1.62% on Monday to a low of 1.50% today. Still, the Fed showed us in June they expect one to two hikes this year. Given where market rates are, they may still be overly hawkish.
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