In the Hollywood spoof Bowfinger, Eddie Murphy’s neurotic action star tries to keep his dread at bay with whispered self-reminders, including Happy Premise #3: "Even though I feel like I might ignite, I probably won’t.”
Fed Chairman Ben Bernanke keeps trying to script a happy premise for monetary-policy worrywarts to repeat into the mirror. He’s been accentuating the point that the Fed is in no hurry to reduce the liquidity support of a $3 trillion balance sheet and an indefinite intention to buy $85 billion in fixed-income assets per month.
Such a soothing maxim might go something like this: “Every time I worry Bernanke will tighten policy early, I should remember that someone trying to be late usually succeeds.”
Last month, when the minutes of recent Fed deliberations showed some policy members arguing for exploring a phasing out of QE, stocks were briefly spooked, triggering the start of the one measurable dip so far for 2013.
It's Greek to investors
Investors fear a tapering-off of Fed asset purchases because too many believe the Fed’s efforts, almost alone, have lifted stock indexes toward new highs. It’s a bit like the ancient Greeks’ faith that Atlas was supporting the world: It wasn’t disprovable and didn’t do anyone much harm to cling to the belief.
Sure, zero interest rates on overnight money and regular cash injections help flush capital into all parts of the economy and asset markets. But this was always the case; it is different today only in degree, not in kind.
The expression “Don’t fight the Fed” goes back decades. Accommodative Fed policy has been an ingredient in every bull market of modern times. There’s more at work, though, as there always is. The market since 2009 has generally tracked corporate profits higher and mimicked the stair-step improvement in unemployment claims.
In any case, investors should try to stop flinching ahead of a tightening blow that is unlikely to come any time soon. Bernanke’s message has been consistent and recently strenuous, even as he's allowed voices of dissent to air their views.
Bernanke used a speech last Friday to knock down the idea of proactive monetary tightening, which have had dire results in past instances. The Fed does not anticipate ending its extraordinary accommodations until “well into the recovery” and will maintain asset purchases until the economy attains “escape velocity,” Fed Vice Chair Janet Yellen said in a speech Monday. The Fed's "Beige Book" checkup on economic trends released Wednesday showed only gradual improvement, nothing like escape velocity.
A win-win calculation
Indeed, Bernanke posed the calculation as a sort of win-win. With a resolve to keep short rates anchored low until an employment recovery is beyond doubt, he suggested that long-term rates would gradually edge higher only if it became clear to the markets that a stronger economy had taken hold.
If the Fed were to hurry a tightening move, he offered, it would “carry the risk of short-circuiting the recovery, possibly leading – ironically enough – to an even longer period of low long-term rates” as the market priced in recession relapse risk.
In other words, Bernanke is promising that the market will get to the point of pricing in a more vigorous economic pace before he does. Therefore, if long rates don’t rise, he’ll stand pat – and will be justified in doing so, because, as he just said, if the economy isn’t strong enough to push bond yields higher, then it still needs the Fed’s extraordinary help. He will err on the side of being late. In a way, we'll be lucky if a tighter Fed becomes a proximate concern.
One useful way to view things is that Bernanke is urgently focused on the beginning conditions of the next recession. This means a determined effort to drive down the unemployment rate and re-engage the slack production capacity by the time another downturn hits. The great risk, by these lights, would be another recession where unemployment remains anywhere near current elevated levels, which could turn a lost economic decade for the average household into a lost generation.
Michael Darda, chief economist and market strategist at institutional broker MKM Partners, says, “It would be a terrible tragedy to end up in recession with historically high unemployment, and with inflation so low -- a violation of the [Fed’s] dual mandate.”
Because unemployment remains so far above the Fed’s 6.5% threshold for considering raising short rates, and benchmark inflation is comfortably below the Fed’s danger zone, Darda expects the Fed to work to elongate this business cycle by supporting the growth cycle.
Naturally, such assurances by the Fed won’t keep the market from reflexively flinching now and then, even if the monetary blow of tighter policy hasn’t been thrown. If, say, the February jobs data Friday show a much larger than expected jump in payrolls, talk will again spread of the Fed’s hawks swooping in to truncate QE. But the threshold for changing policy – ultimately set by Bernanke – is far higher than one or a few hot bits of economic data.
None of this promises a free lunch, and doesn’t mean investors should stop worrying altogether and learn to love the Fed.
The Fed’s easy stance can’t insulate the economy from potential “growth scares,” nor does it reliably underwrite ever-higher stock prices. Global growth rates have slackened lately, the federal government is spending less and the Standard & Poor’s 500 index has suffered setbacks of between 9% and 19% in each of the past three years, even with loose money as the rule. Fed policy has moved from being the primary catalyst for big market moves to merely the assumed context in which investors operate.
Finally, none of this addresses the potential excesses and future “financial accidents” that could arise sometime down the road from an unusually low, uncommonly predictable cost of money. Fears of such unwelcome outcomes probably call for some “happy premises” of their own (stay tuned).