THE FED’S EVOLVING APPROACH: REDUCING UNCERTAINTY BY INCREASING UNCERTAINTY

5/11/13

The Fed is apparently seeking to unwind its brobdingnagian stimulus program in an orderly, gradual manner.  Fed Chairman Ben Bernanke and his minions would also like to avoid upsetting the markets and hence is planning to provide something of a road map of the path it will follow back to what might be described as monetary normalcy if we had any idea what such normalcy is after all several years of monetary stimulus and de facto Fed economic management.   As Dallas Fed President Richard Fisher, one of the saner Fed figures, put it Friday

“We don’t want to go from wild turkey to cold turkey,”

especially in an environment in which the markets look to every Fed utterance for direction at best and for reasons to overreact at worst.

So the Fed says that it is concerned about sending mixed and confusing signals to the market.  However, at its last post-meeting statement, just a few days ago, the Fed stated that it is

“…prepared to increase or reduce the pace of its purchases” according to its view of the economic outlook.”

Philadelphia Fed President Charles Plosser said in an interview on Friday that the aforementioned post-meeting statement was designed

“…to remind everybody” that the Fed has “a dial that can move either way.”

“Increase or reduce the pace of its purchases”?   “A dial that can move either way”?

Do such utterances and references from Fed estimables sound like part of an effort to provide guidance and reduce market uncertainty?  

It is, of course, deleterious to have a monetary authority that has said that, in an effort to reduce uncertainty and provide the markets with guidance, it will decrease, but maybe increase, or, on the other hand, perhaps just pause its monetary stimulus in accordance with its outlook for the economy.  But the Fed’s seeming efforts to provide guidance by saying it will do whatever it feels like doing is especially dangerous in this era in which the Fed has been vested, by the government, the financial community, and itself, with powers that transcend monetary policy.  The Fed has become more than a regulator of banks and the instrument through which monetary policy is conducted; the Fed has become something of an economic czar, a central planner for the markets and, to a lesser extent, for the financial system and the economy.   See my 2/16/13 post CZAR BERNANKE’S DIKTAT:   BONDS MUST BE RICH, STOCKS MUST BE CHEAP.  When such an economic Wizard of Oz says that it has a “dial that can move either way,” and that policy will be adjusted according to the whims of perhaps three or four economic shamans, the markets, and consequently the financial system and the economy, are in a lot of trouble.

Contrary to much of the blather one hears in the financial media, the markets cannot, and should not, demand certainty; see my 1/14/13 post in the now defunct Rant Finance titled MARKETS DO NOT HATE UNCERTAINTY!, which is reproduced below for your convenience.   But a lack of certainty is one thing; an economic uberjuggernaut that deliberately sows confusion in the name of averting confusion is another.

PROMISED REPRODUCED POST:

MARKETS DO NOT HATE UNCERTAINTY!

1/14/13

Today I heard today, for about the millionth time in the last few years, an eminent investment expert say that

“Markets hate uncertainty.”

This utterance was the proverbial straw that broke the camel’s back.   I’ve been wanting to write this piece for months, if not years, and this last vocalization of this inane thought pushed me over the edge.  Perhaps I am picking nits here, but such an argument hurts the ears of this investment maven who’s been around longer than he’d like to admit and has invested more profitably  than most of the eminent experts.  

Markets don’t necessarily prefer uncertainty, but they don’t hate uncertainty.  To say that markets hate uncertainty seems to imply that there is some “normal” time during which there is no uncertainty, a period of, well, certainty to which the markets are accustomed.  

But there is NEVER a period of certainty in the markets.   If there were certainty, where would be the risk?   And if there were no risk, where would the potential for return? 

Markets might prefer periods of less uncertainty, depending on the price paid, in terms of potential returns foregone, for the marginal reduction in uncertainty.  But markets would never prefer a period of absolute certainty.   If such a supposedly halcyon state of affairs were to exist, why would we need markets?   And where would risk, and return, seeking investors go?

Markets constantly operate in an environment of varying degrees of uncertainty; the markets are an exercise in and a mechanism for dealing with and pricing uncertainty.  Risk is in the very nature of markets.   Markets cannot hate their very nature.