Comstock Partners, Inc.March 20, 2014
The Fed's Futile Quest For Transparency
In our view the market frenzy over the FOMC statement and Janet Yellen’s press conference remarks was much ado about very little, and resulted from the market’s quest for Fed transparency that is impossible to fulfill.
On the surface, the FOMC statement seemed quite dovish, stating that it would be appropriate to maintain the target range for the fed funds rate for a “considerable period of time” after the end of Quantitative Easing (QE), even after employment and inflation approached the Fed’s goals. Taken alone, there was nothing in the statement to justify the market’s harsh reaction. If anything, it would seem as if policy was even easier than it was prior to the meeting.
There were, however, two factors that made investors take notice. First, the so-called “dots” that indicate the views of all the Fed Governors as to where the fed funds rate is likely to be at some future period indicated a slight rise in projections. Specifically, the forecast showed a funds rate of 1.13% for year-end 2015 and 2.42% for year-end 2016, compared to their previous forecast of 1.06% and 2.18%. Although this was an increase of the projection by a mere .07% for a point almost two years away and 0.24% for a point three years out, the change loomed large in the eyes of investors.
Second, in answering a question by a reporter as to what was meant by “a considerable period of time”, Yellen said, almost casually, that it was hard to define, “but probably means something on the order of around six months or that type of thing, but what the statement is saying is that it depends on what conditions are like.” The answer, seemingly given reluctantly in the most off-hand manner, was immediately pounced upon by the market as virtually the only significant item to come out of the meeting, although Yellen tried to emphasize that, in the end it really depended on the data.
The problem is that in analyzing the Fed’s statements, projections, press conferences and speeches, investors are desperately seeking a kind of transparency that is impossible to achieve. Neither the Fed nor anyone else can possibly know future economic conditions with anywhere near enough precision to know exactly what they are going to do even six months out, let alone one to three years.
In addition, in its efforts to be transparent about future policy moves, the Fed is reliant upon forecasts that have proved to be highly inaccurate in the past. In January 2011, the Fed forecast GDP growth of 3.7% for 2011, 4% for 2012 and 4% for 2013. The actual respective results were 1.7%, 1.5% and 2%.
Rather than looking for the elusive transparency from the Fed, we are focused on what they are doing now, and what the domestic and global economies are telling us. The Fed is gradually reducing QE at a rate that will end the program at the October meeting, effective November. That, to us, is the first step in tightening monetary policy, and it is happening at a time when the U.S. economy is still stuck in its 2% growth rut, as it was before the weather became the major factor to blame. In addition, as we discussed last week, the Chinese economy is becoming a heavy burden on all of the economies dependent on their exports to China. The stock market has come a long way in the last five years and is now priced close to perfection at a time when global economic growth is under pressure and geopolitical problems proliferate. We continue to believe that the risks, at this point are exceedingly high.