(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
July 10 The Federal Reserve, after a long
campaign to become more transparent, now appears to be unhappy
that it is so well understood.
Along with letting us know that QE is likely to come to an
end in October, Wednesday's minutes from the June meeting of the
Federal Open Market Committee were notable for a rather badly
aimed shot the U.S. central bank appears to have tried to put
across the bow of exuberant financial markets.
Specifically, the Fed seems to be wondering how to put the
mystery back in its relationship with investors.
"Participants also discussed whether some recent trends in
financial markets might suggest that investors were not
appropriately taking account of risks in their investment
decisions," according to the minutes.
"In particular, low implied volatility in equity, currency,
and fixed-income markets as well as signs of increased
risk-taking were viewed by some participants as an indication
that market participants were not factoring in sufficient
uncertainty about the path of the economy and monetary policy."
In plain English, the Fed wishes investors were a bit more
jittery and a bit less fat and happy. To be sure, they have a
point about overconfidence: this is the week in which a
little-known social media company with one employee (whose other
job, apparently, is to promote medical tourism to Tijuana) and
no revenue achieved a market cap of over $5 billion. (here)
But why exactly, given the Fed's own stance, it would expect
investors to be more cautious is a lot less clear.
Fed watcher Tim Duy, economist of the University of Oregon,
points out that the Fed, after all, is now showing a lot less
uncertainty in its own economic forecasts, with far fewer
describing themselves as having higher than usual uncertainty
about key data than one or two years ago.
That leaves their own policy as the main other potential
source of uncertainty.
"If the Fed has a well-communicated reaction function, and
there is little uncertainty about the outlook, why should there
be uncertainty about the path of monetary policy? The Fed's
unease about complacency seems misplaced. The goal of the
communications strategy should be to limit uncertainty regarding
the path of monetary policy by clearly defining the objective
function. The only residual uncertainty will be economic
uncertainty.," Duy writes. (here)
POLICY MAKERS NOT POLICY OWNERS
An interesting insight into the Fed's mindset may have been
given by Jeremy Stein, the now departed Fed governor who gave
his first post-office interview to the Washington Post on
"I have continued to be puzzled by how low various measures
of volatility are, which concerns me a little bit," Stein said,
in response to a question about the challenges the Fed faces in
"Based on the fundamentals, if you think about all the
uncertainty about what's the right long-run rate, when is the
Fed going to lift off, it just doesn't feel like this is a very
low-volatility environment." (here)
Stein is exactly right: investors should be far more
uncertain and in consequence prices ought to be a good bit lower
for most risk assets in order to reflect the potential costs of
To call this puzzling, however, I think is a bit inaccurate,
and Stein is reasonably well placed to understand why this
should be. Stein, who chose to return to Harvard, was the Fed's
leading advocate, in an understated Fed way, of using monetary
policy as a tool to sometimes control overheating markets.
That view has been resoundingly rejected by Fed Chair Janet
Yellen, who instead believes that macroprudential measures,
essentially regulation and suasion, are more effective for
controlling market excesses.
While acknowledging "pockets of increased risk taking across
financial markets", Yellen continues to see justification for a
sort of church and state separation between monetary policy,
which should look after employment and inflation, and
macroprudential policy, which aims to keep markets and
The problem, to put it bluntly, is that investors can read.
They understand that the Fed isn't going to be pouring cold
monetary policy water on the market, and that, at least so far,
the preconditions for a rate hike have not been reached. Wage
growth is weak, and though inflation is trending in the right
direction, it still is not at the Fed's 2 percent target.
That may not be wise, but that's what markets, and the
investors who make them up, are like.
The Fed, in other words, has communicated all too well.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at firstname.lastname@example.org and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)