No, really: look to economists for nuance on Fed’s decision-making

October 29, 2015

U.S. Federal Reserve Chair Yellen testifies before a House Financial Services Committee hearing on Capitol Hill in WashingtonFor all of the incessant talk from market trading desks on how economic forecasters are hopelessly off track on just about everything, their collective thinking on the subtleties of Fed policy near a potentially historic turning point has been well worth listening to.

Never mind the now-template-like charts recycled on social media almost daily, plotting the upward-sloping strands for rate and bond yield forecasts since the dark days of the financial crisis seven years ago. One commentator likened them to U.S. Presidential candidate Donald Trump’s hair caught in the wind.

Markets have no claim to consistency on this, with many a fortune lost on bond market bets on rising yields that were far too early and went the wrong way. (Remember “Bond King” Bill Gross’ famous call when he was at PIMCO that the UK government bond market was sitting “on a bed of nitroglycerine”?)

You can’t plot each bad trade from the moment they were put on to the moment they went sour. But the big banks’ earnings off of fixed income haven’t exactly shown they are masters of the universe, never mind of the yield curve, since the crisis.

Interest rate futures went into the Federal Open Market Committee’s October meeting correctly thinking there was nearly a zero chance of an interest rate hike then but at best a one in three chance of rate hike in December.

They came out the other side scrambling to price in far greater chances of a December move given the FOMC statement made crystal clear December was in their sights.

Veteran Fed watcher Lou Crandall at Wrightson ICAP wrote:

The other modest changes in the statement were more or less balanced.  If anything, we’re inclined to view them as slightly hawkish on balance due to the removal of the warning that international turbulence might restrain U.S. growth, but the changes would not stand out in the absence of the pointed reference to the December meeting.

The Reuters Poll of over 90 economists conducted more than a week ago was much closer to the Fed’s thinking and message than markets were.

A strong majority forecast a December move, but with a low and wavering conviction rate (55 percent) given the data have been less than convincing. The latest hurdle will be just how much third-quarter U.S. economic growth was knocked down by a huge inventory rundown.

Economists, even as a group when they are so often accused of failing to call turning points, spotted the Fed wavering on its September meeting as well. But unlike markets, which had discounted the chances of a move far more greatly, that survey captured the subtlety of the decision.

It was a close call, as will be December’s deliberations. That is what markets weren’t telling you until Wednesday evening.

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