What good is transparency if the future’s unclear? Not much if you’re turning over stones in the bond market in search of clues about what’s coming.
Fed Chairman Ben Bernanke has been warning that the central bank is more or less making monetary policy on the fly these days. As new numbers on the economy come in, the Fed will adjust its monetary prescription accordingly. Gee, thanks.
If it’s not already obvious that ours is a great moment of transition, Bernanke reminded everyone of this fact in his testimony yesterday to the Senate Banking Committee. On the subject of the next interest-rate meeting on June 28-29, he advised that “we have about a month to go before the next FOMC meeting and a lot of data between now and then. We will be watching that data very carefully,” reports Reuters. In other words, the Fed may hike rates but perhaps it won’t.
The bias was on the side of pausing earlier this month. Where did Mr. Market get that idea? From the Fed, of course, which explained in its May 10 FOMC statement that “some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.”
The notion that the Fed would take a breather in raising rates has found traction in the bond market. Although the yield on the 10-year Treasury moved higher in the two days after the May 10 FOMC meeting, it’s been coming down since then. The fact that this morning’s report on April’s new orders for durable goods was surprisingly weak only adds momentum to the case for lower yields. But if you’re feeling optimistic, today’s April’s new home sales’ release–which dispatched an unexpectedly robust gain for the month–is just the thing.
For every bull, there is a bear these days, each armed with data supporting their case. If there’s a belief that a 5.0% Fed funds rate may be the high watermark for awhile, there’s a competing school of thought that thinks any effort to halt the rate hikes at this juncture is a mistake. A glimpse of this opposing army of hawks was seen yesterday, when sellers gained the upper hand in fixed-income trading by delivering one of the more convincing jumps in yield in recent memory. The 10-year’s yield at one point yesterday was as high as 5.08%, a sharp rise from Monday’s intraday low of 4.99%.
Higher rates are eminently reasonable, advises David Gitlitz, chief economist of TrendMacrolytics. Writing in a note to clients yesterday, he opines that “the bullish case for bonds is essentially built on the same flawed logic that drove the short-lived
yield curve inversion earlier this year, and we expect this episode to end no better for the bulls.”
Gitlitz, as you might have guessed, is skeptical of forecasts calling for a weakening economy, the driving force for buying bonds and thereby lessening yields. If the economy stumbles, monetary tightening will quickly become déclassé for fashion-minded central bankers. But Gitlitz thinks that the so-called smoking guns supporting the economy-is-slowing school aren’t really as potent as they appear. Meanwhile, “An avowedly ‘data dependent’ Fed, we think, will remain in rate-hiking mode for at least the next few meetings as the data will give very little support to the economic bears,” he predicts.
In any case, choosing sides on the economy’s near-term future seems to be essential decision of the moment for dictating investment success and failure. Perhaps the extraordinary challenge that awaits in getting this bet right is suggested by Bernanke’s preference for a wait-and-see approach to policy pronouncements. If the Fed is playing its cards close to the vest, maybe no less is prudent for everyone else. On the other hand, with the central bank sitting on the fence, espousing clarity holds the potential for looking like a hero–if you’re right.
As for Mr. Bernanke, one might ask if monetary policy–a tool that invariably has a long-term influence–should be driven by short-term decisions. Yes, it’s possible that between now and the end of June that earth shattering economic changes that no one saw coming will arrive. But don’t hold your breath. Any one data point is but the tip of the economic iceberg. Surely the Fed, with all its resources, has an inkling of where the world’s largest economy is headed and what the inflationary trends will be. Then again, maybe not. This, after all, is the age of conundrums.
History reminds that the Fed has a history of making poor, even disastrous policy judgments, the early 1930s and the 1970s being the obvious examples. But the central bank isn’t likely to repeat such mistakes. The solution, however, may be no less risky. Indeed, the risk of choosing the wrong policy at the wrong time may be yesteryear’s problem, but the Fed may go to the opposite extreme by exercising extreme and perhaps imprudent caution and inaction when something more is warranted.
There are no free lunches in the 21st century. Risk, on the other hand, remains an enduring force, albeit in evolving forms.