Wall Street's big controversy today is whether the Federal Reserve lost credibility when it decided to keep flooring the economy's accelerator, after months of suggesting it would ease off the gas a bit.
Here's a clue: If all of Wall Street is debating whether or not you have lost credibility, then you have probably lost at least a little bit of credibility. And the Fed has managed not only to step on its own message, but hurt the economy in the process.
Starting back in May, Fed Chairman Ben Bernanke and other Fed officials warned markets repeatedly that the Fed could soon cut back on the amount of bonds it buys every month ($85 billion currently) to keep interest rates low and boost the economy. This dreaded event was known as The Tapering, and Fed officials made it clear it would probably start in September.
But guess what: It didn't start in September after all, shocking financial markets. Now there is no telling when The Tapering will start. The Fed set the market up for a taper and then didn't deliver.
Of course, the Fed did say that its tapering depended on the economy's strength, and the economy is clearly not all that strong. But the Fed knew very well that the market expected it to taper anyway, and it did nothing to try to change the market's expectations. That is the sort of thing that damages credibility.
Update: Reinforcing this idea, a new Reuters poll finds that 33 of 48 Wall Street economists think the Fed's communications leading up to the meeting were "unclear." The words "horse dung" were mentioned.
Sure, there is little evidence of a loss of Fed credibility in financial markets, notes Steven Russolillo at The Wall Street Journal's MoneyBeat blog (my old job). Bond yields and currencies and such are behaving as if they believe the Fed's message about the long-term path of interest rates, Russolillo points out. So the situation is not totally out of hand.
But look at all the quotes in his post:
“The Chairman has lost credibility in our eyes." -- Mike O’Rourke, chief market strategist at JonesTrading
“The Fed clearly has work to do before communication becomes a credibly policy tool.” -- Michael Cloherty, head of US rates strategy at RBC Capital Markets
“The FOMC shocked markets and harmed the credibility of its efforts at transparency and forward guidance.” -- Joshua Shapiro, chief U.S. economist at MFR Inc
These go along with other notes I've seen in my inbox, including:
"the Fed lost credibility by not tapering..." -- Christopher Vecchio, currency analyst at DailyFX
"I can’t help but think that the Fed permanently dented their credibility." -- Peter Tchir, founder of TF Market Advisors
"the Fed raised questions about the credibility of forward guidance." -- Scott Minerd, global chief investment officer, Guggenheim Partners
I could really go on and on with that, but you get the picture. Then you also have The Wall Street Journal's Jon Hilsenrath, widely (and incorrectly) considered to be the Fed's mouthpiece, writing on Thursday that the Fed raised "new questions about how effective they are at communicating their thinking." (Shorter Hilsenrath: Call me, Ben!)
This kind of thing matters because the Fed's clumsy communications have done real damage to the economy. Taking the Fed at its word, the market went ahead and assumed the Fed would be buying less bonds, which drove mortgage rates and other borrowing costs higher. That is a threat to the fragile recovery in the housing market.
Bernanke on Wednesday said that the Fed delayed tapering partly because interest rates had jumped since May. But that was nobody's fault but Bernanke's and the Fed's. Currently the market doesn't know what to believe about the Fed, raising the potential for more volatility in interest rates.
Is this a disaster? No. But when the economy is as sluggish as it is now, every little mistake feels much bigger.
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