In his time at the helm of the Federal Reserve, Alan Greenspan elevated “Fedspeak” to a low art.
When push came to shove, Greenspan could be pretty forthright about what he thought about the financial markets – remember the famous “irrational exuberance” comment about the big bull market of the mid-1990s? But when the Fed Head didn’t want to move markets, well, he just didn’t talk, or talked endlessly in so oblique a way that parsing his statements would have required the help of a philologist. That even gave rise to a much-repeated joke: An old friend bumps into Greenspan at the Kennedy Center, and asks how he’s been doing. Greenspan, dourly, replies, “I’m not allowed to say.”
The problem with Ben Bernanke, Greenspan’s heir, is that he does talk – he has made a concerted effort to bring a new level of transparency to Fed communications – but sometimes without conveying a clear message. It’s not that market participants must struggle to decipher the literal meaning of his words, as with Greenspan, but rather that they don’t know which message emanating from the Fed most accurately reflects Bernanke’s real opinion.
That’s certainly been the case of late. Just how dovish is the Fed chairman now, and what should investors make of the apparent debate among his colleagues on the Federal Open Markets Committee? Bernanke said the data over the coming weeks and months would determine the Fed's path, but his answers and the minutes of the latest meeting of the Federal Open Markets Committee sowed the seeds of confusion. That's not Greenspan-style Fedspeak, but Bernanke's version left investors scratching their heads nonetheless.
Deciphering what is meant is far more critical today than it was a decade ago. Yes, it has always been important for investors to successfully second-guess what the Fed is up to: Changes in interest rates and especially in direction will always be important in shaping the value of financial and real assets alike. But in mid-2013, we are nearly five years into a series of quantitative easing programs; moreover, as of last December, the Fed boosted the size of its current open-ended bond-buying from $40 billion to $85 billion. The result? A prolonged period during which interest rates have been lower than most have ever witnessed as the Fed has fought to ward off deflation, fuel economic growth and reduce unemployment levels.
Keeping rates so low for so long has had consequences for financial markets of all kinds, however. It has become absurd to use the polite term for junk bonds, “high-yield bonds,” since those below-investment grade securities really don’t offer high yields any longer. Earlier this month, the yield on the Barclays U.S. Corporate High Yield index dropped below 5 percent for the first time.
Many stocks with high dividend yields are sought after by investors – to the point that some investment advisors are now cautioning clients to steer clear of certain dividend stocks as overly risky. Then there is the argument that quantitative easing has fueled the stock market rally by forcing investors searching for returns to take on risk in stocks. Without the Fed’s largesse, will the bull market vanish? Certainly, the threat has been enough to rattle stocks and send volatility sharply higher.
Last week brought home just what is at stake, beginning with events in Japan, where the link between monetary policy and the equity market’s blockbuster performance is far more pronounced. On Thursday morning in Tokyo, the market received a violent shock, the likes of which hadn’t been seen since the Fukushima earthquake, as stocks fell 7 percent. It wasn’t that the Bank of Japan backed away from its quantitative easing plan; rather that investors succumbed to a fit of the jitters. But some Japan skeptics have pointed out that the stock market’s gains had outpaced the central bank’s ability to repurchase assets via quantitative easing.
“Market enthusiasm … has run far ahead … of the likely pace of easing that Japan’s central bank can reasonably accomplish,” pointed out Paul Christopher, chief international strategist at Wells Fargo Advisory. “The rally in Japanese stocks took no account of the Bank of Japan’s likely need to move incrementally, in order to avoid provoking aggressive selling of Japanese government bonds.”
The United States isn’t Japan, and, as Christopher points out in his letter to clients, investors here are less reliant on central bank policy than those in Japan. But the Fed’s mixed messages aren’t helping much as calling a halt to QE3 becomes a hotly debated topic both inside and outside the bank. Anyone looking to Fed policymakers for clues is deluged with conflicting signals.
Bernanke said last week that asset prices are “not inconsistent with fundamentals,” a statement that, in and of itself, shouldn’t provoke a selloff even if it doesn’t ignite a fresh round of enthusiasm for stocks. At the same time, Bernanke gave notice that the Fed could begin reversing the quantitative easing program sooner than many bulls had anticipated – more specifically, at one of the “next few meetings” of policymakers. Bernanke he hastened to note that he doesn’t want to move prematurely. But then the minutes of the FOMC meeting revealed that some of those policymakers would be happy to start reversing QE3 next month.
“This is not easy and requires good communication,” Bernanke confessed in his comments to Congress. Clearly, that’s easier said than done. Already, the failure to deliver a consistent message has contributed to market volatility. With every day that passes and every report that shows an improvement in the job market, that is only likely to increase.