Alan Greenspan was the master of the overstated understatement. A group of investors could listen to his testimony and come away with diametrically opposed interpretations of what he had said. By contrast, Ben Bernanke has promised a new openness and clarity, but it has been slow going so far. It is my belief that he has a bit of a tin ear to the markets. He had not come to the realization that HE IS the news and billions of dollars of bets are spring-loaded in computerized trading systems hanging on his every word. Greenspan had a lot of faith in the markets. He listened to them, and he talked to them. If he saw the traders going off in the wrong direction he would say something simple and clear to get them back on the right track. If he thought they had it about right, it seemed to me that he became more obtuse. Next week we have the first real test of the Bernankespeak. The Fed meeting on September 18th, is now on the lips of everyone from cab drivers to cowboys. Will he, won't he? That is what we are all asking, and all of us have become closet economists arguing our points of view, no matter how silly or off the wall they may be. At the rate we are going, by next Tuesday, all of the markets will grind to a halt awaiting the Fed's decision on interest rates. In the midst of all the talkers are a group of investors who are making bets, so to speak, on the outcome via Fed Fund Futures. Bloomberg has a new analytical tool that extracts the implied probability of changes to Fed Funds by analyzing the trading data. Today's readings for Fed Funds Futures, are as follows:
- 4.75%. . . . . . .74%
- 5.00%. . . . . . .26%
If you do the math, 100% of investors in Fed Funds believe at least a .25% rate cut is coming. Significantly, and perhaps surprisingly 74% of investors believe a .50% cut is at hand. I'm in this latter camp for reasons I have discussed earlier.
Here's where everyone is flying a bit blind. If Greenspan would have seen this Fed Fund action and he had no intentions of cutting rates by half a percent, he would have Greenspeaked it --talked it down.
We don't know if that is how Bernanke is going to operate. He may believe in more openness but less guidance and less Bernankespeak. If this is the case, my thinking is a quarter percent cut will be viewed as a disappointment by the stock market and it may well sell off. Heaven forbid if rates aren't cut at all.
The saving grace is the Fed's statement accompanying their decision. They can still signal there intentions in the statement which would have the effects of muting the actual move they might make. That may be where Mr. Bernanke has decided to speak.
I can't remember a Fed meeting in years where so many investors are so confused about the outcome. Should make for an interesting day.
6 comments:
I believe it will be a quarter point, because a quarter point and a half point will have the same effect on the economy and a quarter point runs less risk of inflation. But perhaps I should explain.
A quarter point will be a disappointment to the market, but Bernanke's job is not to keep the stock market going up at a steady and uninterrupted pace. But a quarter point, together with some clear words about "continuing to monitor the situation" might be good for the economy over the next couple months and sends an overall positive message that the Fed is prepared to act.
A half point will have the same effect on the economy because of the message it sends. A half point sends the message, "The Fed thinks there's a problem!" and if people start thinking that the Fed thinks there is a problem, then we really have a problem. And this would cause as much problem in the economy as the "real" problems.
Anyway, that's my 2 cents.
Regards,
Shawn
Shawn,
Doggonnit, are you one of those economist guys, who thinks rationally about these things? I buy what you are saying and you make a similar argument to Mike Hull, our president.
I think the Fed needs to signal that there is trouble, because there is.
I'll buy you a glass of Canadian ice wine if the cut is 25 basis points, if you'll reciprocate for me, if the hike is 50 basis points.
Thanks for your interest and input.
Great discussions regarding the Fed in the last couple blogs as well as the follow up comments. Leaving aside the guessing about what the rate change might be next week, I think that one of the key points that Bernacke has been making is that risk should be more appropriately priced. During the Greenspan era, many of the financial risks became grossly mispriced (underpriced) because the Fed had always taken steps to bail investors out of their poor choices. This is not healthly if one is taking a long term view of the economy.
By "not healthy" I am not referring to the asset bubbles that can be created - these are not healthy either - but to the flow of funds into investments. The most productive use of funds occurs when capital flows to the most worthwhile endeavors. When relative investment risk of these investments is mispriced we tend to "waste" our capital by putting it into the wrong places. Our economy becomes less efficient and we create fewer goods and services for the same amount of resources.
The Greenspan era created a lot of happy investors by generally keeping rates lower than they should have been. The long term seeds of inflation were planted and now Bernacke has the thankless job of navigating the narrowing gap between recession and inflation spurred by Greenspans policies. So far Bernacke has done quite an admirable balancing act, but the next several years he will face challenges that Greenspan never had to face.
Greg,
Ben is not Al. His "tin ear" to the market isn't. He just will not let the tail wag the dog... the only thing that the market has gotten dead wrong is that they are still trying to call the plays out of the Greenspan playbook---which I believe has either been shredded or had many pages ripped out. I think Ben has done what he says, and it's pretty plain. There isn't any special translation needed, so people are making mistakes by trying to read into comments instead of taking them at face value. I will be shocked if the Fed does more than 25bps, and I'd be more surprised by 50bps cut than a "nothing done".
You all know that I am a Greenspan fan, which is not to say that I am opposed to Mr. Bernanke. He was my pick. I truly believe that his understanding of the events that produced the 1929 economic crisis was how he and Greenspan became commrades and, thus, a big reason he was named chariman.
In each of your comments, I am sensing some classical training in economic policy, so I don't want to try to explain things to you that you probably know better than I do. However, grant me this point, if the central bank does not pay attention to the markets, we are in for some very volatile markets in the future.
From a classical perspective, volatility is defined as risk. If risk is perceived to have risen, then stocks will trade at lower PEs. Now maybe they should, but Greenspan's "leading strategy", which in my mind did pay attention to the markets, allowed for above trend economic growth, above trend employment without pushing up inflation, and above trend stock market performance.
For Mr. Bernanke to say, "I don't listen to the markets," in my judgment would be a mistake. I'm not speaking of bailing out, but offering guidance.
Before Greenspan, we had a nothing but booms and busts. Greenspan gave us at least two softlandings, and as you know, even in 2001 we did not have two negative consequtive readings in economic growth, which is still amazing to me.
I know your comments are aimed at doing what is right based on its impact on inflation, and with employment still under 5% and oil prices going through the roof, it doesn't feel like inflation is a dead duck.
Greenspan would say, inflation and employment are lagging indicators. The real time indicators are signalling a steep slow down.
Consumer Confidence fell off the table today. I'm convinced the economy has rolled over, and the Fed needs to get out ahead of the situation.
?
Hi Greg,
I don't actually drink (not the fine Canadian ice wines, nor the cheap Chinese counterfeits), but how about supper? If it's a half point, you can come over for supper the next time you're in Ottawa, and if it's a quarter point you can treat me the next time I'm in Evansville. By the way, where is Evansville? 8-)
I admit that it's dangerous to apply the principles of rational thought to how people are going to react emotionally. And for all the measurable and quantifiable factors in the economy, emotion (aka consumer confidence) magnifies them all. But of course we shouldn't complain; the disciplined investor can pick up some good companies on sale when they are oversold.
By the way, did you get time to look at any Canadian banks?
Regards,
Shawn
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