Federal Reserve Chairman Ben Bernanke’s new policy of openness has much to recommend it, in that it gives the markets information about current and future monetary policy that removes some of the guesswork of years past. But now that traders and investors have better insights into the thinking of Fed policy makers, they don’t seem to be acting on that knowledge. Seeing is not believing, apparently.
How else to explain the market reaction to the Fed’s revelation this month that a majority of its Federal Open Market Committee (FOMC) and alternates are diffident about Mr. Bernanke’s promise to continue his near-zero interest-rate policy through 2014. What one would expect to be a shocker, given the crucial importance of super-low rates for borrowing and lending throughout the economy, seems to have produced a big yawn.
The perverse sentiment among the Fed governors and regional presidents who decide monetary policy was made public in connection with the minutes of the committee’s April meeting, released in mid-May under the new openness policy. A set of charts aggregated the expectations of the 12 committee members and five alternates of future economic circumstances, and their views on what interest-rate targets the Fed should adopt over the next three years.
All but three of the 17 surveyed lined up in Mr. Bernanke’s near-zero camp through this year, but five favored higher rates in 2013. By the end of 2014 all but four have left the Bernanke fold. Thirteen want at least a quarter-point increase and seven believe 2% or above would be appropriate by the end of 2014. Beyond 2014, all but two favor 4% or above.
In the old days of Fed secrecy, a chart like this would have been pure gold to traders and investors. Imagine, an inside look at what’s cooking in the Fed’s kitchen!
But there is little evidence that securities markets are taking this news seriously. If they were, 10-year Treasury bonds would not be yielding a measly 1.7%. That’s a negative return if you use the 2.3% annual growth of the Consumer Price Index as a measure of inflation. Indeed, the Treasury was able on May 24 to auction seven-year notes at a yield of only 1.2%, a record low.
Buyers of these high-price, low-yield Treasury securities are taking a big risk on top of the negative yield they face at the very start. Assuming a normal upward-sloping yield curve, Treasurys will fall in market value when the Fed’s short-term interest-rate targets go up. If you believe the sentiment reflected in the Fed’s survey, buying Treasurys is a surefire way to lose money.
What could explain this anomaly? One could accept Mr. Bernanke’s own assessment that these are just opinions and hence not a reliable indicator of what the committee might actually do. It’s true that Fed policy makers are mere mortals, and even with their above-average IQs they are no better able to guess the future two years out than you or I.
And it’s a cloudy future, to be sure. The November election could be a game changer, or at least one might hope so. Nobody knows for sure how long the federal government will continue running deficits in excess of $1 trillion or when the Fed policy of buying massive amounts of this debt will touch off an inflation high enough to do serious economic damage and bring down public wrath. Nobody knows whether Congress will allow a huge tax increase to bang up the economy when the 2003 tax cuts expire on Jan. 1. Nobody knows the future of China, our big creditor, or Europe, a threat to international financial stability.
Yet another possible explanation for this seemingly irrational nonresponse to the news of discordant views among Fed policy makers is that traders and investors now have a better understanding than in the past of the Fed’s limitations in influencing the course of the economy. Four years of rock-bottom interest rates have brought nothing but tepid economic growth. Loan demand is weak despite those bargain rates. The old days when financial journalists held the Fed chairman to be the master of the universe, more important than the president, are gone.
Fed glasnost has destroyed the Fed mystique. Traders and investors have looked inside the Fed’s kitchen and found that there is a lot of guesswork going on in there as well.
Maybe this is all to the good. It might demolish the destructive belief that the Fed can micromanage the economy, producing full employment and other miracles in the face of errant public policies committed by other institutions of government, just by weakening the dollar. On the other hand, the slavish belief by investors that Treasurys are a haven—at a time of massive federal deficits—is more than a little bit disturbing. If nothing else, the opinion sample shows that Fed policy makers are growing restive, too.
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