LONDON Federal Reserve Chairman Ben Bernanke now knows why uncharted waters on mariners' charts used to be marked ‘Here be Dragons'.
The U.S. central bank's disclosure on June 19 of a rough route map for phasing out its unprecedented program of bond buying by the middle of 2014 drew a fiery reaction from global markets. Investors immediately speculated that an end to the Fed's near-zero interest rates would follow sooner than thought.
Clearly startled, Bernanke and his fellow policymakers have been trying ever since to placate the monsters they awakened. That raises the question what they could have done differently to convey their message that a gradual end to asset purchases did not portend a prompt rise in borrowing costs.
Julian Jessop, chief global economist at Capital Economics, a London consultancy, sided squarely with Bernanke, giving him nine out 10 for his communication.
"It's been perfectly clear what Bernanke has been saying and what the Fed has been saying. If there's a problem, it's with the market understanding these things and also the media reporting of them," Jessop said.
Bernanke sought anew to set the record straight on Wednesday in a speech to the National Bureau of Economic Research (NBER), stressing that a highly accommodative monetary policy was needed for the foreseeable future.
The Fed chief spoke soon after the release of the minutes of the Fed's June 19 meeting, at which policymakers delegated him to set out an indicative timetable to 'taper' its bond buying.
Bernanke's subsequent comments last month sent markets into a tail spin. But he stood by them in his NBER appearance, arguing that highly leveraged investors might have been misled into taking even bigger bets if the Fed had kept its intentions to itself.
However, Marco Annunziata, chief economist with General Electric, and said Bernanke had merely ended up tying himself in knots trying to justify the Fed's position.
Annunziata chided Bernanke for trying to micromanage market expectations because ultimately there is only so much the Fed can do to smooth the return to more normal monetary conditions.
"The Fed's June minutes and Bernanke's statements at the NBER yesterday increased confusion on the Fed's policy intentions," he said in a note. "The result will be continued high volatility as markets adapt to the changing environment and refocus on fundamentals."
COULD BE CLEARER
Jessop said the Fed chief could not win.
"He's damned if he does, damned if he doesn't," he said. "There is a risk that the more information you provide, the more markets misinterpret it. Equally the less information you provide, the bigger the vacuum that people might fill with things that are completely wrong."
Investors, however, can be forgiven for being confused by the intricately worded minutes of last month's deliberations by the policy-setting Federal Open Market Committee, which reflect the views of all 19 voting and non-voting members alike.
"We are not sure how you can go from 'many' needing to see labor gains before tapering begins to half seeing bond buying ending by year end. At the same time, 'many' other Fed officials saw bond buying into 2014," said Adrian Miller of GMP Securities.
Or, as a note by Dutch bank ING put it: "FOMC minutes - it's a mess!"
The Fed is perhaps paying the price for keeping markets in the dark nearly 20 years ago.
Investors are still haunted by what Nick Kounis, an economist with ABN Amro in Amsterdam, called the 'ghost of 1994', when a sudden, sharp Fed tightening triggered a bond rout.
Markets know short-term interest rates will have to rise at some point. They just do not know when, and they do not want to be caught flat-footed when the cycle inevitably starts to turn.
Against this backdrop, Kounis said it was hard to argue against maximum transparency on the part of the Fed to minimize the risk of being misinterpreted. Yet that is what happened.
"They've tried to be quite clear about this, but either the message got lost in translation or the markets had their own scenario for the way the Fed would react and did not think the message was credible," Kounis said.
The Bank of England and the European Central Bank, dismayed to see their own bond yields rising in reaction to the Fed, provided 'forward guidance' to investors last Thursday. Like the Fed, they said they would keep interest rates exceptionally low as long as growth was weak and inflation subdued.
Jessop with Capital Economics said the Fed was right to make clear that monetary policy would stay looser for longer than in a normal economic cycle.
But he said the mode for forward guidance was not without risks. Central banks could end up tying their own hands.
"It's important for the markets and the media not to expect central banks to be too explicit, because they can't be. They can only set out the board principles," Jessop said.
"The Fed doesn't necessarily know more about outlook for the economy and potential shocks than the rest of us. So it would be unrealistic for them to commit now to an exact profile for policy in the future," he added.
(Editing by Hugh Lawson)