I am constantly amazed at how the markets misunderstand Federal Reserve Chair Janet Yellen. It seems like many FOMC meetings are followed by a fixed income rally. I woke up last Tuesday and saw a very prominent analyst call for a hawkish signal from the Fed. My reaction was, "based on what?!?" I read his explanation and it STILL didn't make sense how someone could weigh all factors and come up with that conclusion.
Then I thought about something I read a while back in college:
It is said that if you know your enemies and know yourself, you will not be imperiled in a hundred battles; if you do not know your enemies but do know yourself, you will win one and lose one; if you do not know your enemies nor yourself, you will be imperiled in every single battle.
2,500 years later, I am quoting it because it still applies!
Why was I thinking about Sun Tzu? It seems to me that people are thinking more about what a central bank could do, and NOT what a Yellen-led central bank would do. If you look back recently, many other central bankers have been somewhat unpredictable. For example, Kuroda, Draghi, and Jordan, all seem to take delight in "surprising" the markets.
Since many of us are affected by what the FOMC does, we need to know our "enemy" Yellen. Think about the person that Yellen is:
· She shows up three hours early to the airport. She wants to make sure she doesn't miss the flight. The risk of missing the flight is much greater than the inconvenience of showing up early. This has the smell of "the risk of a premature rise in rates," no?
· She is a meticulous note-taker and writer. Apparently, her notes were legendary in graduate school. She doesn't want to miss anything. Under her watch as Vice Chair and then Chair, the number of words in the FOMC statement quadrupled from about 150 to about 600 currently.
· Her hobbies are: relaxing family vacations, eating and cooking. She apparently likes to read economics books on the beach... on vacation! And she likes to discuss economics at the dinner table (her husband has a Noble Prize in economics). She also has a stamp collection. None of this should surprise you. Draghi likes to go mountain climbing. This also should not surprise you.
· She is an excellent economist. It is not a coincidence that her dots have presumably been one of the low ones during this period of slow growth. And she oversees the FOMC research department - the group that spends a lot of time at every FOMC policy meeting presenting the Economic Situation, the Financial Situation and the Economic Outlook.
· She has regular meetings - with everyone. She wants to know what people are thinking. She is friendly, but this also helps her build consensus and allows her to gauge what is going on around her. She even eats at the cafeteria regularly to talk to the employees of the FOMC.
· She is VERY confident in expressing her views. She was a prominent Fed voice as the Vice Chair and now as the Chair. So when I say she is "building consensus," she is nicely explaining to others why they are wrong.
Cautious, meticulous, laid back, planning, consensus-building, growth-oriented people DON'T do things like give a "hawkish signal" or put back in the "balance of risks" phrase when: (1) the unemployment rate just upticked 0.1 to 5.0%, (2) Q1 GDP is 0.5%, (3) Q2 GDP is looking to underwhelm noticeably, (4) there is still no inflation and (5) there are still no wage pressures. Is it really any surprise that the FOMC Statement came out the way it did? It shouldn't be. You can thank Sun Tzu.
The second part of Sun Tzu's wisdom is to "know yourself." In the context of developing a better understanding of the FOMC going forward, know your biases, tendencies, strengths, weaknesses and areas for improvement in processing the overwhelmingly large amounts of evidence around you. For example, would you have the same view, independent of your current positioning? Hoping for a particular result could cloud your judgment. Are you weighting the words of all FOMC members the same? You should pay particular attention to some, while others can be ignored.
Know not just "yourself," but everyone else who is also trying to know the "enemy," Yellen. Understand the biases of the sources of information you are relying upon. Not everyone has the same goal of getting to the truth. Some traders may want to misdirect the market. Some analysts may have a conflicting goal of gaining fame by making a big outlier call. Some in the media may want to spur viewer interest, at the expense of the truth. Certainly not everyone will have conflicting goals - but enough people in each group to cause confusion. Only when you know "yourself," know these "selves" and know the "enemy" will you not be imperiled.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.