
The Fed’s Problem? It’s Too Transparent
NEW YORK (TheStreet) -- Knowledge may be power, but too much of it can lead to inertia. Just look at the Federal Reserve.
Steadily increasing transparency by the central bank since the 1970s has made setting monetary policy a mind game between Wall Street and Washington, D.C., policymakers.
The result? A ludicrous debate on whether the Federal Reserve should increase the federal funds rate by a puny 25 basis points.
And everyone has an opinion, not only on when the Fed might take such an action but what it might look like. The consensus now is that a 0.25% rate hike will eliminate the current rate floor of 0% and increase the ceiling by 0.25%, yielding a federal funds rate of 0.5%.
Others say that the first rate hike in nine years may simply remove the 0% floor and leave the ceiling intact at 0.25%, which is not really a hike at all.
It's a different world than in 1972. When I began my career as a bond trader at one of 12 primary dealers, Arthur Burns was the Fed chair. Fed policy at the time was much more direct, but considerably less transparent.
Policy changes were handled in secret, with tactics implemented through the Open Market Trading Desk of the New York Federal Reserve Bank, which bought and sold securities through primary dealers to achieve the desired federal funds rate.
Rate decisions weren't announced publicly after each meeting of the Federal Open Market Committee, so traders had to pay attention to the market. When the Fed bought securities, it increased the amount of money in the banking system, which tended to bring the rate down. And vice versa.
Of course, as a bond trader, I had an opinion as to what purchases and sales meant with regard to Fed policy, and once or twice a month, my peers and I attended meetings at the New York Fed where we shared those opinions and answered questions from the central bank about market conditions.
The bank used that information to assess how its current monetary policy was working.
But the Fed's actions were largely opaque. The lack of transparency is illustrated by the fact that the central bank didn't send out press releases on monetary policy decisions until 90 days after they were made.
Later, between October 1979 and October 1982, Fed Chair Paul Volcker began setting policy by targeting the supply of money, specifically non-borrowed reserves, which represent the portion of total reserves in the banking system that have not been lent to depository institutions.
This strategy caused the cost of money as measured by the federal funds rate to fluctuate significantly. As a bond trader at a primary dealer, I remember a "shock and awe" press release in late 1980 that raised the federal funds rate by 2% to the 19% to 20% target range.
Here's a chart that shows the history of the federal funds rate.
In 1982, as the inflation of the 1970s finally came under control, the Federal Reserve shifted its primary focus back to the federal funds rate.
Here's a graph of the inflation rate the Federal Reserve tamed with "shock and awe."
Weekly adjustments to the money supply continued to cause bond market volatility. The Federal Reserve announced money supply data called M2 at 4:30 p.m. every Thursday afternoon. Originally, this data was released Friday afternoon, but many market participants complained during summer months that it interfered with weekend trips to the Hamptons.
Under this policy feature, if money supply was growing faster than expected, it was bearish for bonds; slower than expected would be bullish. Many Wall Street trading desks had office pools betting on what the money supply data would be.
Here's a graph of how the Volcker Fed popped the bond bubble.
This policy mechanism ended in July 1993, when Fed Chair Alan Greenspan began targeting the federal funds rate only. That continues to be the policy today.
I remained a government bond trader or trading manager until 1989, and since then, the Fed's shift toward progressively greater transparency is obvious.
To sum it up, since 1970, the central bank has moved from "secret finessing" under Arthur Burns to the "shock and awe" of Paul Volcker, to the planned "spoon-feeding" of today that began with Alan Greenspan.
Now, it's so open that market participants are learning "Fed speak" and parsing every word and phrase in a Fed statement.
This is no way to run the world's most important central bank.
This Thursday afternoon, the latest Fed statement and comments by Fed Chair Janet Yellen during her press briefing will be key to trading in bond and stock markets around the world.
My advice to the Fed? Just do it. Start the process of raising rates. It's long overdue.
Here's how to trade the pending volatility that will follow the Fed's decision, or lack of one.
Related stories:
- What happens when the Fed hikes interest rates?
- Why it's so hard for the Fed to raise interest rates.
- The good, bad and ugly outcomes on higher interest rates.
- Everything you wanted to know about the coming Fed rate increase.
- Three things the Fed may do at its meeting this month.
- What the Fed is watching in the economy before it makes a decision.
- Why the Fed should be raising rates now.
This article is commentary by an independent contributor. At the time of publication, the author held no position in the stocks mentioned.











