By Richard Yamarone
Sunday, June 18, 2006
The financial markets seem to be having a hard time deciphering the latest statements by Federal Reserve Chairman Ben S. Bernanke regarding the Fed's intentions and the state of the U.S. economy. Who ever thought it would be possible that Alan Greenspan's successor could be tougher to understand than the King of Obfuscation himself? After all, Greenspan was famous for his unintelligible prose, even reportedly proposing marriage to NBC's Andrea Mitchell three times before she realized what he was asking. Bernanke, by contrast, is the plain-spoken economist who entered the job in February preaching greater openness for the Fed. Nevertheless, it seems the new Fed chief is not quite the old Fed chief -- and that is creating a ruckus in global financial markets.
Bernanke's recent comments on inflation and monetary policy have been blamed for the heightened volatility in international markets, with stocks and commodities falling -- and then rebounding somewhat -- from Wall Street to London to Tokyo. Some analysts worry that his statements could prompt a downturn or even recession in the United States. All that's a bit unfair. Bernanke is just doing his job, speaking about economic conditions in an honest manner. Isn't that what we wanted?
During his confirmation hearings last November, Bernanke testified, "I expect, going forward, to look for other opportunities to increase the transparency of the Federal Reserve." At the time, it seemed that straight talk was indeed a desired trait of an incoming Fed chairman, a breath of fresh air following 18 years of Greenspanese. I had visions of the Fed conducting open-ended conversations about the economy and interest rates, very much like in graduate school.
After Bernanke's first semiannual testimony before Congress in February, I wrote to my clients that his appearance was essentially a wet firecracker -- he did not jolt the markets, thus earning an A-plus on his first assignment. Trust me, it is no easy feat for the nation's chief monetary policymaker to sit in front of long-winded legislators, attempt to understand their "questions" and respond without saying something that might upset stock and bond traders around the world. The non-reaction following Bernanke's comments was proof of his success.
But, like so many things in life, Wall Street should be careful what it wishes for. A clear Fed chairman who would be candid with investors sure seemed like a good idea. That was, until April 27, when Bernanke testified before the congressional Joint Economic Committee and suggested, "At some point in the future, the [Fed] may decide to take no action at one or more meetings," meaning that it may stop the steady increases in short-term interest rates it had carried out over the past two years.
This about-face caught investors off guard, and sent many economists -- myself included -- back to our computers to rethink our Fed policy estimates. Everything I had projected in October 2005 was predicated on continued Fed rate increases through August 2006. In a nutshell, I was toast. My clients were, too, if they'd been listening to me.
Luckily, I didn't have to wait long before Bernanke surprised the markets again -- this time in my favor. The following Monday, while Washington was hyperventilating over comedian Stephen Colbert's overly pointed performance at the White House Correspondents' Association dinner, financial markets went into their own tizzy when CNBC's Maria Bartiromo reported that Bernanke had spoken to her at the dinner and expressed disappointment with Wall Street's interpretation of his comments to the Joint Economic Committee. Mariagate quickly tossed the markets back to where they had been before the Fed chairman's testimony, permitting me to keep my previously constructed forecasts.
Confused yet? Now you know how I've been feeling lately.
Market participants know that the Fed makes policy decisions with the best interests of U.S. consumers and investors in mind. Nothing is more economically debilitating than higher prices. If unchecked, eroding purchasing power could easily send the economy southward. That's why we have had tough talk on inflation from the Fed chairman and the rest of the Federal Reserve over the past few weeks. Calling recent inflationary trends "unwelcome" at a bankers' conference this month, Bernanke signaled that he would remain vigilant and take action -- in the form of continued rate increases, if necessary -- to ward off higher prices.
In some ways, Bernanke is a victim of circumstance. The U.S. economy is in transition because of uncertainties in the housing and energy markets. With the Fed's leadership also in transition, the markets now have to forecast the near-term direction of the economy and interpret the musings of a new Fed chairman at the same time. This double duty is frustrating the markets, resulting in drastic day-to-day movements. Rather than accept the tasks of interpreting and forecasting, the markets simply blamed the new Fed chief for their woes. Granted, Bernanke had a few missteps early on -- most notably, Mariagate -- but no irreversible calamities. Even Greenspan uttered a couple of doozies after he inherited the throne from Paul A. Volcker in 1987, and he endeavored to greatness.
Greenspan didn't exactly lay an egg on the doorstep of incoming chairman Bernanke. Economic fundamentals are as good as they've been in the past six years -- economic growth is exceeding its long-term potential, the unemployment rate is low, inflation (outside of energy prices) remains largely under wraps, and interest rates are still low by historical standards. In fact, any economist who said 10 years ago that the global financial markets would be in turmoil -- and upset with the Fed -- under these conditions, would have been laughed off of Wall Street. But that's exactly where we stand today.
So, is the problem the message or the messenger? Speaking like a true economist, it's both. Bernanke has kept his promise of being forthright with the investing public. And I do believe there was a time when he thought that a pause in the interest-rate increases was a credible option. Then, for whatever reason, he abruptly decided against it. Bernanke isn't the only economist prone to changing his position. When accused of being inconsistent, famed British economist John Maynard Keynes once quipped, "When the facts change, I change my mind. What do you do, Sir?"
Unfortunately for the new Fed chairman, the financial markets aren't always as understanding, and ultimately they will determine Bernanke's fate. The Fed chairman may be appointed by the president and confirmed by the Senate, but his real bosses are on Wall Street. Continued confusing talk and uncertainty will produce volatile market fluctuations, and cause all sorts of havoc -- not what Americans want to see, given the uncertainty of the housing market and the energy situation.
Let's hope Bernanke will get some good takeout and find a fortune cookie with the Chinese proverb, "Be quick in action, but cautious in speech." If inflation is indeed a concern, boost those interest rates -- the markets will be grateful in the long run. If inflation shows signs of slowing, then pause and await incoming data. But whatever the decision, don't talk about it. In time, market participants, bond traders and market analysts will come around to appreciate the soft speech and swinging of a big stick. And their message to Bernanke will always be perfectly clear.
Richard Yamarone is vice president and director
of economic research at Argus Research and author of
"The Trader's Guide to Key Economic Indicators" (Bloomberg Press).