Via ConvergEx's Nick Colas,
Google “The Fed” and the search engine will offer to autofill your query with “surrenders”. That’s the result of a WSJ article from today with that title, but it also reflects market concerns that the U.S. Federal Reserve has abandoned its recently more upbeat take on the domestic economy. Well, we’ll get a chance to hear more tomorrow when Chair Yellen makes her semiannual monetary policy report to Congress. There’s not likely to be much in the way of new economic information on offer versus her Wednesday press conference, so the success/failure of this appearance will hinge on the tone she chooses to strike and the conviction investors hear in her testimony and in Q&A.
With so much chatter about the Fed “Losing credibility” with markets, this will be an important chance for Chair Yellen to set the record straight.
“There are no second acts in American lives.” That often cited quote reputedly came from the pen of F. Scott Fitzgerald. You hear it most often as the antecedent to something like “Except for” a public figure, fallen from grace, who magically reappears after a personal intermission to regain fame and glory. In fact, you would be forgiven for thinking that too many celebrities on the American stage have not just second and third acts, but tenth and twentieth ones as well.
The actual quote, from a Fitzgerald essay collection titled “My Lost City”, is “I once thought that there were no second acts in American lives, but there was certainly to be a second act to New York’s boom days.” That’s an entirely different sentiment from the soundbite quote, to be sure. There are clearly second acts, and Fitzgerald’s reference to New York City is especially apt since he was referring to the post-Jazz Age world of the 1930s. Since then, of course, the city has had more acts than a Shakespeare play.
In that spirit we turn to the Federal Reserve and its current Chair Janet Yellen – a policymaker certainly in need of a second act. The curtain came down on Act One yesterday, with her press conference post-FOMC meeting. By dint of both their reluctance to increase the Fed Funds rate and the reduction in longer term interest rate guidance, the U.S. central bank essentially ended all market expectations of a cycle of future rate increases. That inaction gave further credence to the market’s worry that the U.S. economy is stalling, and at a fairly high altitude. The ride down may not be pleasant.
True to Fitzgerald’s actual sentiment, Chair Yellen will get her chance for a second act come tomorrow at 10am she will be sitting in front of the Senate Banking Committee to give her widely followed semiannual monetary report. No, she will not have much new information to report compared to yesterday’s press conference. But she will have another chance to express her confidence in the U.S. economy and (perhaps) reinject the notion that the Federal Reserve is still really, truly, actually going to move on rates this year. Right now, Fed Funds Futures don’t give a rate increase even a 50% chance until after February 2017.
Since one overarching narrative is that the U.S. Federal Reserve has “Lost credibility” with markets as a result of its recent erratic rate guidance, we should consider what that means and what Chair Yellen can do to improve matters. A few points here on what “Credibility” really means:
Increasing popular usage of the word “Credibility” stems directly from the Vietnam War and Cold War experience in America. As a point of reference, it was scarcely used in books and magazines at the start of World War II. Fast forward to today, and a word count by Google Ngram shows its usage at more than 10x of that pre-1940. The turning point came in the early/mid 1960s.
Google searches that include the word have doubled since the Financial Crisis (via Google Trends).
The most common usage through the 1960s was in the term “Credibility gap” – the difference between the publicly stated goals and actions of a government as compared to actual events.
Unpacked in this form, “Losing credibility” carries much more social significance than what one might glean from simply knowing that the word comes from the Latin root “to believe”. It is a phrase that relates not just misbelief but actual mistrust in institutions. That’s a large problem for any central bank, but when applied to the U.S. Federal Reserve it is especially worrisome.
So what approach should Chair Yellen do on Tuesday at her Senate committee meeting to start rebuilding trust?
There’s no shortage of advice online for the search phrase “Recovering your credibility”. Much of it, however, points to items that start “I really screwed up at work, what do I do now?” Unfortunately, the most common first step mentioned is to “Admit your mistake”. And while that may be great advice for most workers, I don’t see Dr. Yellen starting her testimony with “The Federal Reserve misjudged the strength of labor markets earlier this year and believed that a June rate hike was the most likely course of monetary policy. Only later did we see the May Employment Situation Report and then know that our analysis was incorrect. We then also took a hard look at the overall state of the U.S. economy and concluded that growth rates are lower than we thought just a few months ago.”
Not going to happen.
“The most effective way to start bridging the credibility gap is to be more aware of what you say.” Even small examples of over-promising just make things worse.
Before speaking, consider “How can I articulate my ideas and concerns in such a way as to not raise false expectations?”
Also, “Where or with whom do I have special difficulty bridging my credibility gap?” In the case of the Federal Reserve, that would be capital markets.
All this feels like a much more likely course of action for Chair Yellen next week. One cannot help but think that she and the rest of the FOMC knows the first half of 2016 have not been kind to them. Not only do Fed Funds Futures explicitly ignore their guidance, but 2 year Treasuries now yield just 69% basis points – a far cry from the +90 bp of late May. And since the Fed’s own guidance still calls for 1-2 rate hikes this year, the only conclusion to draw is that every bond desk on the planet uses “Fade the Fed” as their mantra.
So expect to hear a very contained Fed Chair next week – no overpromising, just a stable dose of muted confidence. Boring? Yes. But right now boring and consistent is the most effective way to start rebuilding market confidence in the Fed’s message.
Or, as F. Scott Fitzgerald put it: “Personality is an unbroken series of successful gestures.”
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