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Thursday April 20, 2006 - 16:26:02 GMT
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There Is A New Fed In Town

For those who followed Greenspan and knew Bernanke there was never any doubt that the change of guard would yield very significant changes in the way monetary policy is made. Greenspan set policy, some might say in a vaccum...a damned accurate vaccum...on a relatively ad hoc basis. His uncanny ability to get early reads on future shifts in growth and inflation was impressive. But with a skill set so unique to the former Chairman and a new Chairman schooled in textbook monetary economics, rules not discretion are to be used for monetary policy making. Right now the rule is the forecast...put in the March 28 FOMC statement for the first time...Fed expects growth to slow to a sustainable pace. The markets by and large ignored this and instead focused on the directive which was unchanged from the February meeting and read at the very least two more rate hikes (5.25% Fed funds peak).

I think it is also important to acknowledge that when a c bank bases its policy decisions off a group forecast (marries mostly quantitative modeling with some discretion) then it takes a lot of data outside expectations to change the forecast or assumption and by definition the policy outlook. Indeed Yellen said Tuesday that part of the forecast includes some pass through to core inflation. So evidence today of a acceleration in core CPI should not change the forecast...it is in the forecast...and not change the outlook for rates (she said today that she still thinks the Fed is about done tightening).

Greenspan on the other hand often ignored staff forecasts and ran with his own innate ability to read the economy. So the forecast was not the deciding factor for monetary policy under Greenspan. Rather it was the hunch (arguably usually on target, though asset bubbles were his Achilles
heel) that drove rate decisions and very often led Greenspan to fine tune market expectations through veiled messages in the financial press, at times insider firms and often in public speeches. So we became accustomed to OMP (Open Mouth Policy). So markets fixated over every word the Maestro uttered and or penned and now we must get back to basics...the forecast matters most (it is public) and data variations impacting the forecast matter most in determining monetary policy. Is the forecast valid? Yellen made it clear that a single data point will not change the assumption or forecast. The bar is much higher. This is how monetary policy is made in the UK.

And it is not a static process. There are upside and downside risks to the forecasts...ongoing.

I think we need to stop looking for Bernanke hand signals, gestures, deep background briefings for the press, obscure anecdotal data and a one-person stamp on all policy changes when Fed watching ahead. Instead we should look at the Fed forecast and the data...do they auger for change in the assumption or validate the assumption. While I am not arguing to ignore public statements from Fed officials, I am arguing that OMP is no longer in the tool kit to the extent it was under Greenspan. What you see is what you get.

I would blame much of the volatility in US Tsys off late to the fact that the market has not come to terms with the new Fed in town and places far too much weight on the wording in the FOMC statement when as Tuesday proved the minutes are far more telling...they show the risks to the forecast. I would also argue that the days of manipulating market expectations through deliberate deep background briefings of key financial journalists are over. Sure Bernanke and other Fed officials will from time to time speak to the press off the record, but there will be far less if any of the manipulation of message and the medium that we grew accustomed to under Greenspan. Keep your eye on the prize...the forecast (set of assumptions)...and adjust as data warrant (a higher burden of proof).

David Gilmore
FXA
www.fxa.com



 

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