All Eyes Will Be Zeroing In On This
This weekend has brought forth three major papers
that were presented to the meeting of the American Economic Association in San
Diego. Federal Reserve Chairman Alan Greenspan delivered a speech that explained
away why the Fed was better off not intervening to stem the speculative stock
bubble of the 1990s. The remarks by Greenspan, while informative, were not new
and possibly exonerate the Fed from failing to halt the rampant stock excesses
that came to represent the Roaring Nineties.
Fed
Governor Ben Bernanke’s speech spelled out the importance of transparency for
Federal Reserve policy. If the Fed’s language is clear and concise then monetary
policy and investments will be more efficient. He goes so far as to undermine
the secrecy of previous central bank governors such as the highly esteemed
Montagu Norman of the Bank of England. Bernanke believes that the less secrecy
the better so markets will not be caught off balance. Both Greenspan’s and
Bernanke’s left little clue for traders as I regard these speeches as academic
commentaries on where the Fed has been and where it is going. That said, I
believe that the paper presented by Ben Bernanke and Vincent R. Reinhart is much
more informative from a trading standpoint.
The
Bernanke/Reinhart paper lays out the presuppositions that the Fed has at its
disposal to affect monetary policy at near-zero interest rates. When one reads
through their analysis the Fed language of the last three FOMC meetings begins
to clear up. The meaning of that infamous phrase, “…can be maintained for a
considerable period,†begins to make sense. The Fed utilized it for it wanted to
send the markets a statement that this policy will be in place for longer than
statistical data may immediately justify and will be judged by the impact on
inflation which will take longer to ascertain. It becomes clear that the Fed is
using the output gap as its measure of inflationary impact. We have time to sit
and wait and the markets should exercise caution instead of jumping quickly with
every economic release. Low rates with low capacity constraints will ensure that
the Fed stays on hold and if inflation falls even further then the Fed has
several tools in its box with which to enlarge liquidity in the system. The most
telling is what Bernanke/Reinhart term ‘quantitative easing.’ As traders we
should stay alert to the Fed’s policy towards the reserve segment of the banking
system for that is where any change will likely show its hand. An effective
easing of reserve policy will end up as a much weaker dollar and most probably
give a further push to the equity indices.
For statistical releases, the capacity utilization and industrial production will be
the supreme data as all eyes will be zeroing in on excess capacity in the
system. Unemployment, which is always the Big Kahuna of economic releases, is a
tougher read because by Greenspan’s and others’ admissions due to technological
advances we do no know what the pressure points on employment are. It used to be
that NAIRU was considered to be 5% but the late 1990s seemed to put that to bed
and Greenspan seems to want to err on the side of technology smoothing the way
rather than being held to hard and fast numbers. If Greenspan wins points, it is
that he believes that the most important thing for the Federal Reserve is to be
flexible — it must react to the market environment rather than hard and fast
statistical data. That is as it should be for all traders.
As for affecting the dollar — these speeches and papers will have no effect on the
present direction. Fed policy will not change as long as they perceive no
inflationary threat and will err on the side of ease to ensure that the labor
situation in the U.S. improves. The only major event that can force the Fed’s
hand would be a significant sell-off in the long end of the Treasury market for
that could affect corporate balance sheets and forestall any new capital
expenditures. It is only a dramatic weakening in the dollar that could initiate
such an event so that is what we must be attentive to — for if Bernanke is
credible this will lead the Fed to some type of yield curve intervention.
Yra Harris
yra53@aol.com