Loose lips sink ships? Fed’s latest transparency sows confusion, says Mizuho’s Ricchiuto
The complexity of non-traditional monetary policy is hard enough to explain to other economists and policymakers. Market participants prefer sound bites, opines Steven Ricchiuto, chief economist at Mizuho Securities USA in a note. As such, the more the Federal Reserve Chairman Ben Bernanke tries to explain the Federal Open Market Committee’s position on tapering and policy accommodation the more he confuses the message, Ricchiuto says.
The problem is fundamental to the nature of monetary policy. According to the Chairman, monetary policy accommodation is adjusted through the Fed Funds rate. Quantitative Easing (QE) is a separate policy. Yet he has also said that tapering is simply reducing accommodation, not tightening. These pronouncements work at cross purposes and ignore how the markets read policy. For the markets, QE is an extension of policy into non-traditional tools. Therefore, tapering is tightening. There is no such thing as reducing accommodation for market participants.
For the FOMC, it is the stock of bonds that have been purchased that defines policy, Ricchiuto says. Essentially, if the Fed stops buying Treasury and mortgage-backed securities but the Fed’s System Open Market Account (SOMA) doesn’t sell any, then policy is unchanged. This implies that long-term rates should remain unchanged.
To a bond trader, however, it is about the next trade. If the Fed is not going to buy the new issue supply of bonds, rates must rise to attract additional investor interest. As a result, the FOMC claims that the market overreacted to the Fed Chairman’s post-meeting press conference.
The June FOMC minutes further complicate the message because the discussion was less hawkish than the Chairman’s message, Ricchiuto said. Moreover, Bernanke’s comments on Wednesday, July 10, were taken as back pedaling from tapering, even though he repeatedly emphasized that what he was saying was not different from what was said at the late June press conference, he said. “This highlights that the FOMC’s latest steps toward increasing transparency have failed.”
Ricchiuto says a tapering is more likely to begin in 2014 than this year, but is concerned the 10-year Treasury yield will hit 3 percent as a result of this policy confusion, before retracing to the 1.5 percent area.
The markets see QE as the Fed pushing long-term rates lower, whereas non-traditional policy should be focused on deflationary pressures. Unfortunately, even the FOMC appears to have lost sight of this objective.
By linking tapering to labor market developments, the FOMC suggested policy was designed to lower long-term rates and stimulate economic activity. This opened the Fed up to criticism that it was creating financial market bubbles, Ricchiuto said.
These concerns have become a problem for the Chairman, especially as he considers his legacy. The net result has been a confused policy dialogue and undesired interest rate volatility.
All the while, inflation continues to decline and the latest import price data suggests that the risk of importing deflation is increasing, Ricchiuto says.
The headline import price series fell by 0.2 percent in June, continuing a series of declines that started in March. The year-over-year measure is now down to just 0.2 percent.The non-fuels series was down 0. percent in June, and the year-ago change is now -1 percent. Year-over-year declines were also recorded in the price of imports coming in from both China and Japan, -1 percent and -2 perdcent, respectively.