In the minutes for the May 10 meeting, the Federal Reserve gave no indication that it intends to end its interest rate hikes anytime soon, although the minutes do not preclude such a possibility.
The lack of a clear designation to either the amount of hikes that remain or the possible timing to the end of hikes appears to be creating additional angst in the markets, but very little has actually changed. The Fed is data-dependent, after all.
Uncertainty about policy is an unfortunate reality at the moment, a point made openly by New York Fed President Geithner earlier Wednesday. His comments help tell us why the minutes are not very clear about what's next, as he said that a central bank cannot convey "more confidence in the outlook for growth and inflation than it can reasonably have, and it cannot provide more assurance about the likely future course of policy than it actually has."
Geithner basically reinforced the idea that this is a period much different from the past two years when there was an extraordinary amount of certainty with respect to Fed policy.
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There were actually three major positive developments in the minutes.
1) The Fed said it was contemplating more aggressive rate actions. While this seems a big negative, it would be better than letting inflation creep higher given that the recent acceleration in inflation is eroding real economic activity, something that is very apparent in the most recent data on consumer spending. Recall November 1994 when inflation expectations were also rising and the Fed countered it with a 75 basis-point hike in the funds rate. Bonds began a sharp rally that month and did not look back. A vigilant Fed can be rewarded when the vigilance is timed right.
2) The Fed showed deference (finally) to the rise in inflation expectations apparent in the bond market.
Measures of inflation compensation based on the difference between yields on nominal Treasury securities and inflation-indexed issues had edged higher. It was possible, though, that investors' uncertainty regarding inflation prospects, not just inflation expectations themselves, had risen. On balance, participants judged that inflation expectations had risen somewhat -- a development that would have to be taken into account in policymaking and warranted close monitoring -- but remained contained.
Several weeks ago there were perceptions that the Fed was ignoring signals about worsening inflation expectations in the bond market. Commodity prices were soaring and the dollar was weakening, yet the Fed was signaling an end to hikes. It seemed as if the Fed was making a classic error in putting its judgments up against the judgments of millions of investors.
This is a big no-no for any central bank. It is important for the markets to know that the Fed is headed by a chairman who will pay attention to the message of the markets (kudos to Ron Insana at CNBC for the expression) and is not stuck in academia.
3) The Fed said that it is appointing a subcommittee on communications issues to be chaired by Gov. Kohn (recently appointed Vice Chairman), a major confidant of Greenspan's throughout his tenure. The subcommittee could help to improve some of the communications issues that have plagued Bernanke in the early going and for which many have given Bernanke poor ratings. I have felt, for example, that Bernanke's policy statements have been too wordy, hence making them subject to a greater amount of subjective analysis than was the case under Greenspan.
Interestingly, when Greenspan was dealing with a similar issue back in the latter part of 1999 (some like myself thought that the Fed was not making it clear that more rate hikes might lie ahead, hence feeding the stock market bubble) he appointed an in-house task force headed by Kohn's predecessor, former Vice Chairman Roger Ferguson. The task force's findings led to the construction of policy statements that were used as the basis for all of the Fed's policy statements leading up to Greenspan's arrival. The statements were clear and concise.
Less is More
An interesting aspect of the minutes is its lack of specificity regarding future rate moves.
It seems the Fed wanted to avoid a repeat of the sharp market response that occurred following the release of the minutes from the March FOMC meeting, when investors seized upon the line where the Fed said that "Most members thought that the end of the tightening process was likely to be near." Since, as Geither noted above, the Fed can't provide more assurance about the future course of its rate policy, it is probably best to follow the adage, "less is more." Why talk extensively about what's next when what's next is not yet clear?
It is probably a good thing that the Fed is now choosing to be a bit quieter about when it might end its rate hikes. Announcing a future end date would essentially move that date forward because of the market response that would ensue following such indications. This actually raises the possibility of an unexpected pause.
In summary, for those investors (most these days) worried about how many hikes remain and when the rate hikes will end, the minutes provide no comfort. The lack of any specific reference to what's next has boosted rate hike odds in the market's eyes, with fed funds futures now priced for 74% odds of a June hike, up from 56% before the minutes.
Odds of a second hike have also increased to close to 30% by year's end, up from around 10% before the day began. While discomforting, the Fed's toughness on inflation, its deference to the inflation expectations apparent in the bond market, and its new effort to improve upon its recent missteps in communications are major positives for the long run condition of the U.S. economy and for the financial markets.
Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of
The Strategic Bond Investor
. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback;
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