January 26th, 2012
by Jeff Miller
The Fed made history today, achieving a new level of policy-making transparency.
In 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.
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.
There is a lot of information, so anyone offering conclusions today is only doing a first take. Here is mine.
- 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.
- The long-term policy commitment is matched to the forecast.
- The Fed is prepared to act more aggressively if circumstances require -- QE III.
- The Fed has an inflation target, 2% in core PC.
- Despite pleas from the liberal wing, employment and/or GDP targeting is secondary.
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!
About the Author
Jeff 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.