What is the Federal Reserve Really Thinking?

Barry Ritholtz provides us with a primer on Fed-watching:

The Big Picture | What is the Fed Really Thinking?: Last week's rally was ignited by a simple change of phrasing in the FOMC statement. Market took that to mean not only that increases are off the table, but -- Hallelujah! -- a rate cut is in the offing. Not so fast. Whenever the Fed says or does something that is subsequently misinterpreted, they have a few back door methods to correct the error. Two in particular were used fairly regularly. Call it the Fed edit/correction methodology.

When John Berry was at the Washington Post, he could be discretely contacted. He's now the Fed columnist at Bloomberg, and while I'm sure he maintains his FOMC contacts, we haven't seen him "break news" like his WaPo days. He primarily does analysis, and he is very insightful as to what the the Fed is thinking. That's quite valuable, but its not the same as "getting the call." These days, that takes place with the WSJ's Greg Ip. And in a page one article, he lays out what the news is from on high:

When the Federal Reserve last week altered its post-meeting policy statement to soften the suggestion that it might raise interest rates, Wall Street was confused.

Was the Fed signaling that a rate increase was less likely because the outlook for the economy had darkened? Or was it simply reflecting the reality that interest rates are on hold for now?

The answer to both questions is, yes.

With no one quoted, and no speech is cited, one has to assume this is straight from the horse's mouth. The WSJ doesn't print factual statements about the Fed on the front page without knowing this is precisely what they are thinking. That's simply not how they roll. So we can assume that Mr. Ip. is repeating what he was told by very senior Fed Sources. Consider the specifics of the following:

The Fed is seeing increased risks to its forecast that the nation's economy will grow moderately this year. Those risks include the surprisingly weak level of business investment and the hard-to-predict outcome of the current troubles at the riskier end of the mortgage market. The Fed changed its statement last week to get the flexibility to cut interest rates in coming months if those risks grow. But it is unlikely to use that flexibility anytime soon, because the risks aren't big enough and inflation remains uncomfortably high.

I'll bet you that the last underlined sentence came verbatim from the Fed. If it was not emailed, than it was spoken slowly and repeated. And the surprisingly weak CapEx chart? Yeah, you can assume that has the Fed nervous. Here's another classic insider line (and the word "Housekeeping" is classic bureaucracy speak):

"Housekeeping" played a part, as well. For several months, some officials saw the Fed's previous policy statement, which had indicated rates could rise but not fall, as increasingly inconsistent with their own expectations of unchanged rates for the foreseeable future.

We are only to the middle of the article, and we get the conclusion:

The new statement reflects a Fed on hold. It contains no explicit reference to the direction of rates, saying only that "future policy adjustments will depend" on growth and inflation, but reiterates enough inflation concern to indicate lower rates aren't on the table.

The rest of the piece is worth a read, but after this point its just a standard article. All of the prior paragraphs can be considered dictation...

Comments

[trevelyan]

Brad -- what is the point of claiming that a technocratic elite is "signalling" anything? Isn't this the worst sort of Sovietology? Honest question.

[mickslam]

I read Barry every day. What a smart and kind person he is! I bet you two would get along famously.

trevelyan,

I don't see any problems with this type of signaling. Really this was just clairifcation for the people whos jobs need more details. If you read the statement from the Fed, its pretty clear, but this article removes any ambiguity.

[kharris]

What mickslam said.

It's a sad comment on our educational system that Barry had to interpret Ip who had to interpret (Barry insists) uncited Fed sources who were interpretting a public statement from the FOMC, even though the statement from the FOMC was pretty clear initially.

[mpowell]

I don't know. Maybe I'm just weird, but all of this seems pretty reasonable to me. You have a situation where you really don't want people to be overly confident in their knowledge of what you're going to do, but at the same time you want to be able to provide them some 'guidance'. And especially you don't want them overreacting to changes. That suggests the use of carefully vague public statements followed up by more informal clarification. It is a little like Sovietology, but some of the same dynamics operated there as well.

[jerry]

I think making the Fed's guidance mysterious hocus pocus is crap that favors the rich elites that get inside information and otherwise can pay for their own DeLongs to interpret the statements for them.

It may once have made sense in a day of buggy whips where it took days for news to travel, but in this day of internet speed of communications and a belief in rational people and an efficient market place, it just smacks of collusion.

I think it is bullshit that this practice is never questioned by economists or the business schools.

[Archer]

It still seems odd to me that the Fed would feel compelled to clairfy an overly POSITIVE reaction to its FOMC report (after all, it will come out in the wash) and it turns out I'm not alone in thinking that, per Yves Smith's post at Naked Capitalism:
http://www.nakedcapitalism.com/2007/03/why-does-fed-care-if-it-is-understood.html

[bigTom]

As a non-economist, it seemed pretty obvious to me that we are in a period with both inflationary, and recessionary concerns roughly equally balanced. So the fact that the Fed statement essentially said the same, and Ip's reinforcement of that message should come as no surprise to anyone.

[Matt]

I might be getting a clue, though my clue is uncertain and may be revised to reflect better certainty about my uncertainty.

If the business community is reacting strongly to fed statements, then it is at the end of the business cycle. Businesses are done investing for the cycle and they are showing volatility to short term changes in debt.

In my accounting system, covariance between business and fed banking is too high. In my property banking system, there is too much bank property and too little private property. Property values are too dependent on short term bank actions.

The fed needs to decouple, somewhat, and that means higher short term interest rates.