The following was written by Gavyn Davies and is also posted at his blog. We’d like to again thank Gavyn for having joined FT Alphaville yesterday for our special edition of Markets Live.
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Following yesterday’s live blog on FT Alphaville, here are some quick final reflections on the Bernanke press conference:
1. It was a success. After a hesitant start, the Fed chairman spoke calmly and authoritatively, explaining the Fed’s exit strategy much more clearly than the FOMC statement had managed to do. In fact, in the absence of the press conference, there would have been considerable uncertainty about what the statement actually meant.
2. The tone of the press conference was widely judged to have been “boring”, which simply means that it was aimed more at the financial markets than at Main Street. This is a good decision by the Fed. They must not try to compete with politicians for the ear of the electorate. The ECB press conferences have never made this mistake, and nor should the Fed.
3. The existence of the press conference will probably increase the importance of the chairman relative to other FOMC members. This has also happened in the case of the ECB and (to a lesser extent) the BofE. There will now be somewhat less opportunity for an opaque FOMC statement to be followed by a dozen speeches by individual members, with markets becoming confused about the true intentions of the committee, though this will still happen to some extent (see below).
4. At present, the press conference has probably strengthened the hand of the doves, because the chairman is so clearly still in the dovish camp himself. However, the chairman did try his best to speak for the entire committee, for example by suggesting that the balance sheet could be reduced in size fairly soon (albeit very gradually), and by saying that the “extended period” language on rates offered guidance for only about three months ahead, instead of six months as previously assumed. This was probably intended to placate the hawks.
5. We will soon see whether the hawks now feel a need to redress the balance. They probably will, though the weight placed by the market on their future speeches will now be reduced.
6. As to the message itself, the Fed has now decided to stop easing monetary policy in June, but has not decided to start tightening policy yet. In their thinking, they will only do this when the balance sheet starts to shrink, not when they stop buying bonds. This stock vs flow point is very important to grasp, since it also determines whether bond yields are likely to rise when the Fed stops buying. (See this blog for a detailed discussion of this contentious point.) I favour the “stock” view, which is relatively favourable for bonds, though the real test will now begin.
7. The Fed is not likely to bring forward monetary tightening just because commodity prices cause headline inflation to rise. Although the language on inflation was toughened slightly, the real emphasis was on the following: first, that the impact of higher oil prices on inflation would be transitory; and second that medium term inflation expectations would need to rise before the Fed would get worried. This suggests that the FOMC will tolerate a lot in this area before tightening policy.
8. The Fed chairman managed to give the market the impression that he is very relaxed about the weakness of the dollar, despite his routine comments about the desirability of a “strong” currency. I can only assume that this must have been intentional.
9. There are increasing similarities between the dilemmas now faced by the Fed, and those already faced by the Bank of England. Both are tolerating an overshoot in their inflation objectives because they believe that oil-induced inflation will prove temporary. (Note the ECB takes a very different view.) And both may soon be managing monetary policy in the context of a significant tightening in the fiscal stance. Mr Bernanke’s attitude towards US fiscal tightening had the air of “I-will-believe-it-only-when-I-see-it” yesterday. But if US fiscal policy does tighten in 2012, that would be another reason for keeping monetary policy easy for a long while yet.
Related reading:
Money Supply – FT blog on central banks
Bernanke makes Fed history, not news – FT
Fed raises inflation forecast above goal – FT