Ben Bernanke is an avowed advocate of a more transparent
, and reactionary, anxious markets are the byproduct. Without the mysterious Alan Greenspan at the helm, the curtain has been pulled back on the Fed to reveal Bernanke as a clear, direct economist who admits he has no crystal ball. And the markets are left adrift at sea with no oars.
"Bernanke has been treating us like adults, but he's finding out we're really a bunch of children," says Ethan Harris, chief economist at Lehman Brothers. "Today will be another case where he probably didn't think he'd be hammering the stock market."
But that indeed was the consequence of Bernanke's inflation-fighting comments Monday at the International Monetary Conference in Washington, D.C.
Dow Jones Industrial Average
tumbled 199 points, or 1.8%, to 11,048.72.
was the lone Dow component to end with a gain, while the economically sensitive
were among the biggest losers.
fared similarly, shedding 1.8% and 2.2%, respectively. The markets were already weak Monday, but volume and selling activity picked up after Bernanke spoke at 2:00 p.m. EDT. About 2.2 billion shares traded on the
, and 1.8 billion traded over the counter; losing stocks led winners by better than 3-to-1 in both venues.
Weighing on the averages were energy stocks such as
, which fell despite rising crude prices, tech stocks such as
Advanced Micro Devices
and rate-sensitive groups such as homebuilders, which are already under pressure after cautious comments from
Bernanke acknowledged moderating economic growth Monday, but his tough words on inflation trumped any mention of a slowdown. Core inflation "has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth," he said. "These are unwelcome developments."
Bernanke also noted that a reduction in energy prices would take the pressure off of inflation, but that volatility in energy and other commodities prices remain a risk to inflation. He added that "the Committee must continue to resist any tendency for increases in energy and commodity prices to become permanently embedded in core inflation."
The Fed's biggest worry is not only overshooting with rate hikes, but also that it has failed to stop inflation before it started, says Harris, noting that "inflation builds up in the system behind the scenes." To be chasing inflation while growth is slowing means you have to "slam the brakes on," and you risk recession, he says. It is the "dreaded behind-the-curve" scenario.
Since the middle of last year, many investors had been hoping the Fed would pause after whatever FOMC meeting was coming up next. The hopeful outcry became the "one and done" mantra, which reached a fever pitch in April. Amid the tailwind of strong first-quarter earnings, investors saw the "Goldilocks" economy within reach. The U.S. had strong growth, healthy companies and a slowing housing market that would land the economy back down to earth while the Fed slid into home base in its tightening cycle. Instead, inflation mars the picture, and markets are losing faith. The Fed has missed the sweet spot. Credibility lost again...
Bernanke has been inconsistent since he took office, and he started out dispelling a dovish perception at his confirmation hearing last November. It seems Bernanke doesn't know how to reinvent himself as the new guy in school. (See the table on the next page.)
The chairman's comments Monday trampled on some investors' resurrected hopes that the Fed had room to pause in June. The Fed, via Bernanke and a gaggle of other Fed speakers, had telegraphed at the end of April that it wanted to pause. Who can blame traders for feeling whipsawed by the Fed's communication "strategy"?
On Monday he came out as a hawk just when the markets thought he'd take on a dovish stance given softness in recent economic reports.
Friday's nonfarm payrolls report capped off a week filled with data the markets read as pointing to a slowing economy -- slow enough that the Fed had room to pause. The odds of a fed funds rate hike dropped to below 50% after the jobs report Friday, after spiking to over 70% after the FOMC minutes last week.
Indeed, the slowing economy became the nexus of anxiety in the markets last week as the Treasury market telegraphed an "enough is enough" message to the Fed. The 10-year Treasury yield dipped below the fed funds rate of 5%. It closed Monday yielding 5.02%. The short end of the yield curve steepened, however, pricing in a June fed funds rate hike.
But Monday's stock market reaction was not exactly predictable. Stocks have been unsure which way is up lately when it comes to the Fed. They rallied when the hawkish FOMC minutes came out last week, but that was when the markets wanted to see credibility from the Fed. And yes, the market sold off early last month when Bernanke told
Maria Bartiromo that he's more hawkish than he seemed at his Joint Economic Committee testimony. But that was when the market wanted the Fed to pause.
It seems stock investors don't know if they want tough love and full disclosure or some soothing tones and a little mystery. Sometimes too much information is a burden.
The fed funds futures market flip-flopped immediately Monday, sending the likelihood of a June rate hike soaring from below 50% to 76%. Prior to Bernanke's speech, there was little reaction to the Institute for Supply Management services index report for May. The index dropped to 60.1, in line with estimates, but the prices-paid component surged to 77.5.
Market participants should brace themselves for further volatility this week and, indeed, until the Fed's next policy meeting.
With several of the Fed speakers on tap and another round of key economic reports between now and June 28-29, Wall Street could invent a futures market for the fed funds futures market. One could set their bets that Monday, Wednesday and Friday, odds will top 60% that the Fed will hike the fed funds rate for the 17th consecutive time at the end of June. On Tuesday and Thursday, odds will drop to 40%.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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