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.”