Where Is The Fed: Transparency Land Or Fantasy Land?

Includes: AGG, DIA, QQQ, SPY
by: Robert Brusca

There is a lot being said about the Fed and its new policy. You can be sure that if you trade or invest in bonds or stocks or commodities or foreign exchange what the Fed is doing will affect you. If you breathe what the Fed is doing will affect you …

The Fed talks about its policies being transparent. But in all the years I have been a Fed watcher (many, many - don't ask) I don't think I have ever seen a forecast from the Fed that I thought was less likely than this one. That goes double for the interest rate forecasts. Is this transparency or fantasy?

What is interesting and unexpected is that the Fed's policy statement is getting nearly as much discussion as its new templates that offer up various Fed member forecasts ranging from an update on its macroeconomic outlook to its first presentation ever of individual (but unattributed) interest rate forecasts.

The Fed also released a statement on how it interprets its dual mandate which I still prefer to call dueling mandates. The mandates may not be inconsistent in the long run but the short run they usually are and it is in the short run that the rubber meets the road and where the Fed operates.

It is instructive to peruse various financial publications, web sites, etc. to see what people say that the Fed has done. On balance such a survey will leave you with the impression that the Fed now has an inflation goal and that it is prepared to keep rates ultra-low to 2014 or beyond. Some analysts point out the Fed 'pledge' (as some incorrectly call it) must represent a minimum since the Fed would not use a number unless it were very confident with it.

A Bloomberg article uses the following interesting quote, it is excerpted here: "... It's exactly what they needed to do," said former Fed Governor Frederic Mishkin, referring to the inflation target.

Mishkin is a former Fed governor and a close colleague of Bernanke with whom he has co-authored papers. He wants to make a lot of the Fed's decision to cite in its main policy objective a level that is sought for inflation. On its website the Fed says, "The Committee judges that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate." And the Fed also says this: "In setting monetary policy, the Committee seeks to mitigate deviations of inflation from its longer-run goal and deviations of employment from the Committee's assessments of its maximum level."

What these statements do is to CONFUSE what the Fed has done and where it stands. First of all, the Fed does not have an inflation target if it has a dual mandate as it admits. It has not said anywhere that it has an inflation TARGET. The Bloomberg story quotes Mishkin as saying that the Fed has done something really significant but in the STORY the author goes on to refer to the Fed's inflation "TARGET." Wall Street Journal stories also liberally use the word 'target' to speak of the Fed's goal. But a goal is not a target. When a central bank sets a target its aligns itself with meeting it. The target becomes a measure of the Fed's credibility. Other central banks do 'target' inflation in the way that the Fed itself used to 'target' measures of money supply. But what the Fed has done with inflation is to set it as a goal alongside other 'worthy' dual mandate goals. The Fed is not committed to 2% in the same way as if it were a target.

The reporting on the Fed's willingness to keep interest rates ultra-low adds to the confusion of what the Fed has done. This is no pledge as some say it is. This is only a possibility. If conditions are not right for it the Fed WILL NOT DO IT. And if the Fed decides to raise rates sooner there will be no loss in credibility because the Fed has made no promise.

If you follow this line argumentation carefully how can you join the surge of consensus to say that the Fed is being transparent? The Fed is confusing us. It released a bunch of stuff, 17-different data points representing interest rate projections but how useful was that? We are left with far less knowledge about HOW the Fed thinks. Knowing what it thinks is of limited usefulness. That can change day to day as the facts change. Every forecast is obsolete the minute it is written down. Yet, the Fed tells us nothing about how it really decides to make the tough decisions on growth Vs inflation. That is the core dilemma for the Fed - we have no idea how it will be made.

Is that transparent?

I will caution investors about thinking that interest rates will really stay so low for long. I will caution them that he Fed took an inflation vigilance statement out of its policy statement in January at the same it is trying to convince us it is committed to 2% inflation. Core inflation is actually rising. The Fed is making a bet that Keynesianism is right. It is betting that the large GDP gap will bring inflation back down.

But this is a gamble and the Fed's rate 'promise' is at risk because of it. Do yourself a favor and READ the Fed statement yourself. Read it closely. Pretend you are a lawyer looking for loopholes in it. After doing this do you still think the Fed will be doing what it says?

I don't.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.