The markets overreacted to the Fed minutes


The markets overreacted to the Fed minutes. We already knew there were a few members who worry about bubbles, instability, and inflation but we also already knew that Bernanke is a strong (and dovish) leader who is an authentic expert on the consequences of ending a program too soon (he wrote a book about the policy choices in the Great Depression). Let’s not discount Yellen’s role as a strong voice, too, and maybe a “whip,” although it’s doubtful Bernanke needs a whip.

You have to wonder that if the Fed is so concerned with “communication” and “transparency,” how it could have missed that the markets would misinterpret discussion about changing or ending QE to actually doing it. How could the market take a minority view for an imminent change in policy, especially with strong leadership against the minority view? Besides, Fed chairmen have been known to resign (Volcker) when the members did not follow the chairman’s preference.

The answer is that the Fed almost certainly did not make a mistake. These guys may be mostly academics and not market players, but many are just as Street-savvy as the toughest hedge fund manager (think Yellen). Besides, the Fed knows the market is stupid, in the sense that it forgets what it just did (in September, before QE3) and conflates X with Y. At a guess, the FOMC airing its laundry in public was deliberate—an experiment to see what would happen and probably confirm what it expected. It’s true that the Fed is required to disclose deliberations— we are unsure on exactly how much and on what legal basis—but if the Fed wanted to keep the existence of debate from public view, it could surely do that. To confuse debate with dissent is the error of shallow minds, including those in the Fourth Estate.

As we wrote last fall, we can expect more of the same. For example, the WSJ reports that Morgan Stanley wrote “The Fed minutes have brought forward market expectations that the FOMC will end QE3 in the second half of this year rather than in the first half of 2014." We doubt it. In fact, we won’t believe it until we hear Bernanke himself say something along those lines.

On the data front, today we get existing home sales, probably a drop by 0.8% to an annual rate of 4.9 million in Jan, according to the Bloomberg survey. Sales bottomed in 2008 at 4.11 million after peaking at a record 7.08 million in 2005. Last year the total was 4.65 million, the most since 2007 and a gain of 9.2%.

Also today is CPI, probably a rise of 0.1%, which is chicken-feed but the first rise in three months, according to Bloomberg. Core CPI will be 0.2% or 1.8% y/y. This seems like a lot and near the Fed’s 2% but it’s the smallest year-over-year increase since July 2011. We also get jobless claims, probably a rise for the first time in 3 weeks, at about 355,000 (vs. 367,000 at year-end). The Philly Fed releases its economic index, forecast at 1.1 in Feb from -5.8 in Jan, and the Conference Board leading indicators probably rose 0.2% in Jan (after 0.5% in Dec).

As long as the market remains focused on the Fed halting easing, data won’t count. Normally, good US data makes the world safe for risk appetite and is dollar-negative. Now good data encourages the view that golly, maybe the Fed will end QE sooner, or reduce the amount, or something—and rising rates favor the currency. Since we think the end of QE is a false hypothesis, it’s hard to see the dollar continuing upward for long. When the markets figure out what the Fed really said—and we expect the Fed to let them stew in their own juices and decline to offer any “clarification”—presumably the dollar gets sold off again. The question is which currency is the prime benefi- ciary—it may not be the benchmark euro, which will get very confusing. By all means, jump on bandwagons. But don’t buy the story—it ain’t necessarily so.

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