The Fed Role in the Economy: Now Bigger. Now Better?

January 26th, 2012
in contributors

by Jeff Miller

The Fed made history today, achieving a new level of policy-making transparency.

smoke-puffIn my early days in the business, the results of an FOMC meeting were never announced. Everyone waited until the day after the Fed meeting to see what open-market operations were conducted by the NY Fed. First you needed to know what was needed to maintain the current policy rate. Then you had to gauge whether the action was sufficient to maintain that rate. System-wide repo's were aggressive easing and matched sales were tightening, but there was still a matter of interpretation. Various Fed experts were quoted on the newswires to offer their interpretations.

It was like waiting for puffs of smoke from the chimney.

Follow up:

Now, all of the old skills are irrelevant. It is almost like CNBC putting the stock names on the ticker along with the symbols -- amateur hour!

But that comparison is not fair. Only the skills that have changed.

It is a new era, with a lot more information (See Global Economic Intersection for a great job on the main story and updates with each new piece of information). During recent years -- mostly in the Bernanke era -- we have added all of the following:

  • An official policy statement, carefully constructed and instantly parsed by analysts to pinpoint the nuance of each change;
  • More frequent updating of official forecasts;
  • More timely minutes of meetings;
  • Eventual full transcripts of meetings;
  • Press conferences by the Fed Chair after meetings with forecast updates; and now
  • A granular look at the distribution of forecasts of the entire Board (not just voting members); and
  • A statement of principles about inflation targeting and the lack of an employment target.

This is a feast for anyone with a brain and some analytical skill. I note with amazement that some disparage this information. Then I see that these are the same people who typically criticize the Fed regardless of what it does.

For most of the real world, having more data is valuable for planning and for setting expectations. We all know that the Fed cannot forecast three years ahead with any certainty, and Bernanke agreed in the press conference. These forecasts will change.

The key point is that we will now be able to see the changing long-range forecasts of the members in real time. I am using this in my investing, and so can you if you think about it.

Today's Takeaways

There is a lot of information, so anyone offering conclusions today is only doing a first take. Here is mine.

  1. The consensus Fed forecast is for moderate, below-trend growth for the next two years. Progress on US economic data has been offset by Europe. Modest growth, no recession.
  2. The long-term policy commitment is matched to the forecast.
  3. The Fed is prepared to act more aggressively if circumstances require -- QE III.
  4. The Fed has an inflation target, 2% in core PC.
  5. Despite pleas from the liberal wing, employment and/or GDP targeting is secondary.

Investment Conclusion

The initial market reaction was a rally of less than 1%. This was a knee-jerk reaction toward a weaker dollar, lower long-term rates, higher commodities, and higher stocks -- everyone's first take of the news.

This assessment is partly correct. We all need to consider each asset class. I think that the inflation/weak dollar conclusion is overstated. The chance of a spike in long-term rates is a bit lower.

But here is the big story:

The Fed shows determination to fight a new recession, doing whatever it takes. The votes are there.

This dovetails nicely with our recession series. The method we are putting under the microscope, Bob Dieli's, accurately emphasizes Fed policy as a big factor in recessions. More to come on that subject, but astute readers will see the drift. We are earlier in the business cycle than most analysts think. This is good for heavy cyclicals and cyclical tech stocks. (Think CAT and ORCL and the XLI ETF for names I have mentioned, or write to main at newarc dot com to get our updated ETF suggestions).

This also dovetails nicely with our short-term modeling from our Felix model.

Worst Forecasts Ever

The latest Fed action suggests something interesting for market watchers. For many years there has been a cadre of Fed critics asserting that the Fed was "out of bullets" or "in a box." For any objective observer these statements have clearly been proven false. The latest Fed move is something that non of these "experts" even considered a few years ago. The same guys are now telling you the same thing about the ECB and Europe......They see no hope.

With the 2006 Fed transcripts we can now start to have some fun by looking back at bold assertions about Fed meetings and what actually happened. So many interesting ideas and so little time. Maybe an enthusiastic reader will take this on!

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About the Author

Jeff MillerJeff Miller has been a partner in New Arc Investments since 1997, managing investment partnerships and individual accounts. He has worked for market makers at the Chicago Board Options Exchange, where he found anomalies in the standard option pricing models and developed new forecasting techniques. Jeff is a Public Policy analyst and formerly taught advanced research methods at the University of Wisconsin. He analyzed many issues related to state tax policy and provided quantitative modeling which helped inform state and local officials in Wisconsin for more than a decade. Jeff writes at his blog, A Dash of Insight.

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  1. Dig Deep says :

    Jeff your articles are always informative and clear.

    I'll follow your tack on the days of yore and appreciate your experience and insight into the mechanics of Fed delivery then...
    *There's no way anyone at that time, that could envision the degree of intervention and manipulation by the current Fed, albeit more transparent now.
    *When there was intervention, it was to control the excesses of fraud and easy money (Volcker early 80's).
    *Current intervention avoids the fraudulent acts of excess and with $10T attempts to fight a reversion to the mean of exponential debt growth.

    It all starts with knowledge of production - then the improvement in productivity - that productivity stimulating capital investment - that investment expanding the employment base - and finally then, higher rates of consumption.

    Fed/Gov't interventions have put the cart before the horse over the last 20 years - false growth with leveraged consumption - and the interventionists want more of the same bubb inflate to unsustainable levels.

    We best look at production (and the knowledge thereof) before we get all giddy about 3 more years of mispriced bond yields and liquidity that pumps risk-on behavior --- until it doesn't.

  2. Dig Deep says :

    FYI - hoping for a reply Jeff, you put the challenge out there. I'll check back.

  3. Jeff says :

    Dig Deep --

    For background, we should note that the Fed always dictates the short end of the yield curve and indirectly, the longer rates as well. I see the current policy as less special than you do.

    You have a political/ideological/economic viewpoint about the role of government. This is a subject that I have spent hours on with hundreds of people in seminars, so we will not solve it here.

    With that in mind, I recommend that we not discuss what we think government should do and instead consider what it will do. You have an easy choice. You can spend the next few years moaning and groaning because you do not like Fed policy, or you can figure out what investments will benefit from the information from the new transparency.

    My articles are not about politics, so I emphasize how to make money no matter who is in power -- even if it is Obama:)

    I urge you to join me in becoming a political agnostic when it comes to investments.

    And one last thought -- the bond market is the deepest and most liquid market we have. The Fed moves at the long end only account for a few basis points. I wonder why you are so confident that it is "mispriced?"

    Thanks for joining in. I hope we have some good discussions here, and your viewpoint reflects the thinking of many.


  4. Dig Deep says :

    Jeff you're right.
    Makes sense to deal with things as they are and not as they should be according to me.
    My bias toward less intervention and watching things as 'they are' basically has put me on the sideline.

    I'm not claiming to be smart about sideline/fence sitting - but watching all the manipulations bothers me to my core. I'll rail (in my own little way)against too much central state planning. I don't trust the ability of technocrats to guide the economy and the increased transparency makes me more uneasy.

    I do trust the market - even when it delivers some pain. Natural adjustments of winning and losing make for a sustainable path forward.
    Manipulated adjustments to avoid losing - or to put everyone in a house -or to re-inflate to bubble levels - or to not regulate the derivatives market (where I do believe in intervention /controls)- fostering crony capitalism amongst WS and government -- etc etc - has me and many others untrusting.
    My realization from all of this is to invest in my own business for future income streams. Trusting an over manipulated equity, PM& commodity and fixed income market(s)isn't in my playbook. Viewing the lower trading volumes might indicate that feeling is spreading.

    Back to my first point - you're right in many ways. Always a good read and appreciate your work.



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