The Fed is heading for another catastrophe
6 investing lessons from the Federal Reserve
For years, investors have profited living by the credo “Don’t fight the Fed,” so when the central bank made changes in its verbiage this week — hinting that it could raise rates later this year — it sent investors into a bit of a tizzy.
That said, investors might be better off trying to live by their own version of the Federal Reserve’s words, rather than focusing on its actions.
“Fedspeak” first came into the public lexicon under former Chairman Alan Greenspan, who was famous for making cryptic comments using obtuse word choices. Princeton economics professor Alan Blinder defined Fedspeak as “a turgid dialect of English.”
The latest focus on Fedspeak has revolved around one word, “patient,” but in the past the spotlight has been on everything from “irrational exuberance” and “policy accommodation” to “measured” and “data-dependent.”
Individual investors, of course, are their own central banker, setting their own policies.
If that policy is “don’t fight the Fed,” then you typically would be backing away from stocks now, because when the Fed increases rates, it takes that step to prevent the economy from overheating, which could fuel inflation, and rising rates historically have preceded bear markets and recessions.
But rather than focus on your strategy in the face of the Fed’s wording change this week — because even with the change in language this week, plenty of observers don’t think the Fed will actually hike rates until 2016 — consider instead the Fed’s words that should be the linchpins of your personal policy.
From central bank to your bank account, they don’t change much; what matters is how you define them and apply them.
With that in mind, here are six examples of Fedspeak and how they might apply to your own investments:
‘Patient’
In Fed world, this is a euphemism for “things aren’t changing.” While the Fed was being patient, rates were not going to rise. It’s important to recognize, however, that excluding the word did not mean the central bank was moving all the way to “impatient.”
In an individual’s lexicon, being patient, therefore, amounts to sticking with an investment versus putting it on the “watch list.” When patience starts wearing thin, it’s a sign that you might want to reconsider an investment, shorten the leash that you give a fund manager or a stock when it comes to disappointing performance, and start to think of what your next move might be.
Data dependent’
In Fedspeak, this means that any decision made today holds until there’s some quantifiable reason to change the policy.
It’s no different for individual investors. For example, consider the simple question of “Should I rebalance my portfolio?”
Someone who is not data-dependent considers rebalancing — where holdings are adjusted to put the portfolio back onto its target asset allocation — a regular chore and does it annually, regardless of market conditions. A data-dependent investor would say the move isn’t necessary until the portfolio is 5% or more off of its targets and profit-taking seems prudent.
Investors have to decide which part of their investment program they follow regardless of market conditions, and what moves are dependent on the data, whether that means personal numbers like the return of a portfolio, or big-picture numbers like how they will invest when they finally see a rate hike
In Fedspeak, this means that any decision made today holds until there’s some quantifiable reason to change the policy.
It’s no different for individual investors. For example, consider the simple question of “Should I rebalance my portfolio?”
Someone who is not data-dependent considers rebalancing — where holdings are adjusted to put the portfolio back onto its target asset allocation — a regular chore and does it annually, regardless of market conditions. A data-dependent investor would say the move isn’t necessary until the portfolio is 5% or more off of its targets and profit-taking seems prudent.
Investors have to decide which part of their investment program they follow regardless of market conditions, and what moves are dependent on the data, whether that means personal numbers like the return of a portfolio, or big-picture numbers like how they will invest when they finally see a rate hike.
‘Measured’
Dating back to the Greenspan days — when the former Fed chairman said low-rate policies could be reversed at a measured pace — this is a term that, for individuals, describes slow, considered movements.
For example, an investor nervous about the market being near all-time highs and having been without a significant downturn in more than six years could take the measured response of taking some profits, culling winners and slowly making their portfolio more defensive.
While investors would always like to believe their responses to market conditions are measured, the truth is that many are knee-jerk, in-or-out, all-or-nothing moves. That can be fine — if you believe market conditions call for you to be on the sidelines completely, selling everything could be a “measured” response — but most individual investors want to avoid extremes, so a truly consistent, compromise position tends to work best.
‘Considerable time’
In Fedspeak, this was used by former chair Ben Bernanke and current chair Janet Yellen to signify “for the foreseeable future.”
For individuals, however, a considerable time is more like “enough time.” You want to stick with a new fund manager for enough time to prove that he or she can do as well as the predecessor, you want to make sure your investment strategy is not over-reacting to the nearly random day-to-day machinations of the market.
Ideally, any time an investor makes a move that moves their portfolio in a different direction, they would have given the old strategy — and they’re prepared to give the new one — considerable time to work. Depending on the strategy, the number of days in “considerable” is flexible, but individuals should have their own definition for it in advance.
‘Accommodation’
This is what Greenspan called a policy that was making the most people happy. For individuals, sometimes you need to make your own accommodations, taking actions that might not be textbook perfect, but that work for you.
For example, if you have a diversified portfolio but you’re not comfortable with investing in, say, emerging markets or small-cap stocks, you can avoid those asset classes. Yes, it will affect overall portfolio performance and volatility, but you can make that accommodation so that you sleep better at night. The more comfortable you can be, the easier you can stick with a strategy that you believe will pay off over time.
‘Irrational exuberance’
Perhaps the most famous example ever of Fedspeak, it was Greenspan’s way of warning that excessive enthusiasm for a roaring bull market was short-sighted.
By comparison, “rational exuberance” is something investors should strive for; it’s the excitement someone should feel if they have a strategy that they truly believe will help them reach goals in due time. If the market is making you giddy, you should know that feeling can’t last forever, but it’s okay to be in high spirits when your plans appear to be working.
Best description of FED "say nothing" I read so far
Sorry, the Fed won’t hold your hand forever
Investors are feeling flush and happy after last week’s Federal Reserve meeting offered reassurances that the central bank won’t move aggressively to hike interest rates.
Stocks responded with a huge rebound, leaving the S&P 500 SPX, -0.61% and other major indexes not far off record highs.
But don’t get too comfortable.
The launch of a new rate-hike cycle means that the Federal Reserve’s hand-holding can’t continue forever. For now, it’s taking care to spoon feed market participants a reassuring gruel: Sure, the Fed has dropped “patient” but that doesn’t mean the central bank is “impatient,” as Chairwoman Janet Yellen emphasized.
At some point, however, the Fed will hike rates, and in the run-up to the move, the seeming confidence inspired by the central bank’s willingness to cautiously flag every future move is likely to take a hit. After the first hike, the pace and trajectory of future tightening moves will likely become less certain, rate watchers say.
The problem is that investors have become accustomed to a Fed that bends over backward to offer forward guidance and transparency. The Fed itself seems a little gun shy after the market-shaking 2013 “taper tantrum” that followed then-Chairman Ben Bernanke’s hint that the central bank was ready to begin winding down the last iteration of its quantitative-easing program.
But such a fully transparent Fed isn’t the new normal.
As Thierry Albert Wizman, global interest rates strategist at Macquarie, has noted, the Fed’s recent glasnost is a function of the bizarre world that’s prevailed in the aftermath of the financial crisis. One thing it isn’t, however, is “normal.”
In a note just ahead of last week’s Fed meeting, Wizman observed that the Fed’s various forms of quantitative easing and other extraordinary measures have required policy makers to emphasize certainty. In order for those measures to work, the Fed had to convince investors that the programs were “inviolable, and certain to transpire even if the data shifted.” What people have perhaps forgotten is that telegraphing its moves and committing so forcefully to new policies were never “normal” practices for the Fed, Wizman said.
So although investors are acting relatively certain, things aren’t so pat. In fact, Fed Vice Chairman Stanley Fischer warned in a Monday speech that projections for interest rates to rise smoothly and steadily after the initial hike almost certainly won’t be borne out.
That’s because the economy is almost guaranteed to encounter shocks—”shocks like the unexpected decline in the price of oil, or geopolitical developments that have major budgetary and confidence implications, or a burst of greater productivity growth, as the Fed dealt with in the mid-1990s,” he said.
And that means there is a degree of uncertainty surrounding the level of future interest rates that can be estimated statistically “and that should be taken into account by market participants and recognized by the [Fed] when it discusses the future level of interest rates,” he said. See: Dot plot? Feh. Fed’s Fischer wants fan chart.
In other words, the Fed isn’t out to abolish uncertainty, though it might want to find a better way to quantify it.
No doubt, figuring out how to get back to a more normal level of uncertainty appears to be causing some sleepless nights among policy makers.
Not just the FED but it is becoming more and more pointless now
Why is ANYONE not suprised.
Why is ANYONE not suprised.
It would be a surprise if anybody was surprised 
It would be a surprise if anybody was surprised
That may be the most true statement I have heard all day! Seriously, though, I am reminded of the movie Dave, if you haven't seen it, you should have, where he brings in his accountant to help balance the U.S. budget, and his accountant freaks out and says something to the effect that "If anyone ever ran a business like this, they would be bankrupt before they started!"
Fed's Yellen sees gradual rate hikes starting this year
Federal Reserve Chair Janet Yellen signaled that the U.S. central bank will likely start raising borrowing costs later this year, even before inflation and wages have returned to health, but emphasized the return to normal interest rates will be gradual.
A downturn in core inflation or wage growth could force the Fed to delay the first increase to borrowing costs since 2006, the central bank's chief said on Friday, but policymakers should not wait for inflation to near the Fed's 2-percent goal before tightening monetary policy. The Fed has held short-term borrowing costs near zero since December 2008.
After the first rate increase, Yellen said, a further, gradual tightening in monetary policy will likely be warranted. If incoming data fails to support the Fed's economic forecast, the path of policy will be adjusted, she said.
"With continued improvement in economic conditions, an increase in the target range for that rate may well be warranted later this year," Yellen said at a monetary policy conference at the Federal Reserve Bank of San Francisco.
Yellen added that while the Fed is giving "serious consideration" to beginning to reduce its accommodative monetary policy, the timing and the path of a Fed hike would depend on the incoming economic data.
"The actual path of policy will evolve as economic conditions evolve, and policy tightening could speed up, slow down, pause, or even reverse course depending on actual and expected developments in real activity and inflation," Yellen said.
U.S. Treasury yields fell and held near session lows on Friday after the mildly hawkish comments and as investors bought bonds ahead of month-end rebalancing.
Still, traders of U.S. rate futures kept their bets that the Fed will wait until October to raise rates.
"It turned out to be pretty much a replay" of last week's Fed statement, said Alfonso Esparza, senior currency Strategist at Oanda in Toronto. "They're waiting for the data," he said in reference to Fed policymakers.
Ex-Fed Bernanke: Economy Not Yet Ready to Swallow Rate Hike
The former Federal Reserve (Fed) chairman Ben Bernanke on Monday urged the bank's policymakers to be increasingly cautious against a premature end to the central bank’s zero interest rate policy.
“A premature increase in interest rates engineered by the Fed would…have likely led after a short time to an economic slowdown and, consequently, lower returns on capital investments," Bernanke wrote in a blog post. "The slowing economy in turn would have forced the Fed to capitulate and reduce market interest rates again.”
It was his second blog post - the first was a brief introductory note. While at the helm of the Fed, he was very controlled in his remarks, as investors and the markets closely examined his every utterance.
Exactly wrong to do
Increasing rates prematurely would have been “exactly the wrong thing to do” because the weak, yet recovering, economy would not have been able to swallow greater borrowing costs, he claimed.
He listed a number of occasions when central banks have acted too early, raising rates only to lower them again once the economies worsened.
“Ultimately, the best way to improve the returns attainable by savers was to do what the Fed actually did: keep rates low (closer to the low equilibrium rate), so that the economy could recover and more quickly reach the point of producing healthier investment returns,” he advised.
Geez! And the hits just keep getting better and better.
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America’s Federal Reserve is headed down a familiar — and highly dangerous — path. Steeped in denial of its past mistakes, the Fed is pursuing the same incremental approach that helped set the stage for the financial crisis of 2008-2009. The consequences could be similarly catastrophic.
Consider the December meeting of the Federal Open Market Committee, where discussions of raising the benchmark federal funds rate were couched in adjectives, rather than explicit actions.
In line with prior forward guidance that the policy rate would be kept near zero for a “considerable” amount of time after the Fed stopped purchasing long-term assets in October, the FOMC declared that it can now afford to be “patient” in waiting for the right conditions to raise the rate. Add to that Fed Chair Janet Yellen’s declaration that at least a couple more FOMC meetings would need to take place before any such “lift-off” occurs, and the Fed seems to be telegraphing a protracted journey on the road to policy normalization.
This bears an eerie resemblance to the script of 2004-2006, when the Fed’s incremental approach led to the near-fatal mistake of condoning mounting excesses in financial markets and the real economy. After pushing the federal funds rate to a 45-year low of 1% following the collapse of the equity bubble of the early 2000s, the Fed delayed policy normalization for an inordinately long period. And when it finally began to raise the benchmark rate, it did so excruciatingly slowly.
In the 24 months from June 2004, the FOMC raised the federal funds rate from 1% to 5.25% in 17 increments of 25 basis points each. Meanwhile, housing and credit bubbles were rapidly expanding, fueling excessive household consumption, a sharp drop in personal savings, and a record current-account deficit — imbalances that set the stage for the meltdown that was soon to follow.
The Fed, of course, has absolved itself of any blame in setting up the U.S. and the global economy for the Great Crisis. It was not monetary policy’s fault, argued both former Fed Chairmen Alan Greenspan and Ben Bernanke; if anything, they insisted, a lack of regulatory oversight was the culprit.
This argument has proved convincing in policy and political circles, leading officials to focus on a new approach centered on so-called macro-prudential tools, including capital requirements and leverage ratios, to curb excessive risk-taking by banks. While this approach has some merit, it is incomplete, as it fails to address the egregious mispricing of risk brought about by an overly accommodative monetary policy and the historically low interest rates that it generated.
In this sense, the Fed’s incrementalism of 2004-2006 was a policy blunder of epic proportions.
The Fed seems poised to make a similar — and possibly even more serious — misstep in the current environment. For starters, given ongoing concerns about post-crisis vulnerabilities and deflation risk, today’s Fed seems likely to find any excuse to prolong its incremental normalization, taking a slower pace than it adopted a decade ago.
More important, the Fed’s $4.5 trillion balance sheet has since grown more than fivefold. Though the Fed has stopped purchasing new assets, it has shown no inclination to scale back its outsize holdings. Meanwhile it has passed the quantitative-easing baton to the Bank of Japan and the European Central Bank, both of which will create even more liquidity at a time of record-low interest rates
In these days of froth, the persistence of extraordinary policy accommodation in a financial system flooded with liquidity poses a great danger. Indeed, that could well be the lesson of recent equity- and currency-market volatility and, of course, plummeting oil prices.
With so much dry kindling, it will not take much to spark the next conflagration.
Central banking has lost its way. Trapped in a post-crisis quagmire of zero interest rates and swollen balance sheets, the world’s major central banks do not have an effective strategy for regaining control over financial markets or the real economies that they are supposed to manage. Policy levers — both benchmark interest rates and central banks’ balance sheets — remain at their emergency settings, even though the emergency ended long ago.
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