Good Morning: Our capital markets have lately been, in the words of one of veteran participant, “just scintillating”. Stocks, bonds, the dollar, and even commodities have been stuck in fairly narrow ranges during the past week or so, as can easily be seen in measures of implied volatility that are loitering near multi-month lows. The VIX now sports a 17 handle, down more than a touch from last month’s highs near 30. Investors seem to be waiting for some sort of decisive news flow, the latest candidate being today’s FOMC meeting. And yet, while politicians seem bent on creating headlines that should goad Mr. Market out of his recent slumber, policy makers from EU finance ministers to our own Federal Reserve Governors seem intent on fostering the type of “stability” they so crave. Whether it’s the EU’s continuously evolving policy toward Greece or the Fed’s efforts to stimulate while appearing to remove stimulus, both entities are hoping words alone will help forestall real action.
Yesterday there were stories in the press that indicated EU finance ministers were in disagreement about what to do with Greece (see below). The ideas ranged from doing nothing (“they don’t need our help”), to providing loan guarantees, to the type of bond purchases that will look to their constituents like nothing short of a bailout. Today, however, comes a different story, one of seeming unity on the subject (see below). The ministers have cobbled together some sort of financial “lifeline” for Greece , though sticky details like how, when, and how much have been left for investors to imagine for themselves. “The clear hope is that the mere promise of support will reassure investors enough to bring Greek bond yields down further,” said Ben May, an economist at Capital Economics Ltd. in London (source: Bloomberg article below). Mr. May has it exactly right; the ministers are hoping cheap talk will supplant the need for politically expensive financial support.
Our Fed has a different challenge in front of it, but the FOMC will also likely call upon a press release to do its work instead of substantive policy changes. The governors will debate ways they can thread the policy needle of a monetary stance easy enough to encourage economic growth (thus providing aid and comfort to equity investors) while still appearing tough enough to restrain long term inflation expectations (and thus term premiums in the bond market). Whether the FOMC decides to hike the mostly symbolic discount rate again or shift around a few words like “extended period”, I honestly have no idea. What’s important to remember is what they do, not what they say. No matter how the Fed phrases its press release, the fed funds rate is unlikely to head north any time soon.
Why do I think the funds rate will stay at snake-belly levels? It may just be my read of the situation, but I think the Fed feels its biggest risks are of the economic and political variety. Inflation risks — to them — are distant and manageable. Reading Chairman Bernanke’s old speeches about Japan ‘s need to target “positive inflation” in the midst of their long stagnation might even mean that Bernanke and company would welcome some inflation here in the U.S. But I can’t prove it. What I do know is that the dovish Janet Yellen has been tipped to occupy the vice chair seat next to Mr. Bernanke.
What also seems clear is that the Fed would like an expanded supervisory role in any financial regulatory changes now under consideration. Since this legislative effort falls to Congress to engineer, the Fed may wish to focus on the “full employment” aspect of its dual mandate over “price stability” while its supervisory role is up for debate. On this score, the Obama administration weighed in this morning with its own cute reminder of what it sees as the highest priority for the Fed. Does the following choice of words ring a bell? “The percent of Americans who can’t find work is likely to ‘remain elevated for an extended period,’ Treasury Secretary Timothy F. Geithner, White House budget director Peter Orszag and Christina Romer, chairman of the Council of Economic Advisers, said in a joint statement.” (source: Bloomberg article below).
Other risks to the economic outlook the FOMC may not choose to discuss in today’s press release include the aforementioned financial stresses in Europe, a brewing currency/trade spat with China , and another attempt at passing healthcare reform. What’s more, small and midsize banks have real estate losses that are curtailing new lending; the housing industry is still flat on its back; and the auto industry has potential customers keeping one foot on the brake over new purchases because they can’t be sure if the other foot will cause a new accelerator to stick. There are other risks, too, so the Fed’s plate is a full one today. Like everyone else, I don’t know what words will pour forth from the Eccles building this afternoon. I do know, however, that just like their ministerial colleagues in Europe , the Fed hopes that today’s words alone will be enough to keep various market constituencies calm.
Whether this trust investors still have in our central bank can last is another question. Volatile markets may or may not reappear before the FOMC’s next meeting in late April, but Mr. Bernanke and his merry band of governors won’t be able to rely on words forever. Like fiat currencies, press releases are only worth the paper they’re printed on.
– Jack McHugh
EU Spars Over Aid for Greece, Bets on No Need for Bailout
EU Lays Groundwork for Greek Lifeline to Bolster Euro
Obama Aides See Jobless Rate Elevated for ‘Extended Period’ Fed May Seek to Avoid Lower Inflation as Officials Debate Exit
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