WILLIAM DE VIJLDER Blog - in English

Listening to Bernanke: how transparent should the Fed be?

(Opinion piece in De Tijd - 27 January 2012 - http://www.tijd.be/opinie)

Can transparency ever be too much of a good thing? That’s what I wonder when contemplating the Federal Reserve’s new communication policy. I’m not talking about the announcement on 25 January that the US central bank will keep its policy rate unchanged until late 2014, nor about the 2% inflation target. What I’m still struggling with is the publication of individual FOMC members’ long-term forecasts for the fed funds rate. For economists this publication is a godsend, and in a few years’ time postgraduate students will be eagerly writing up PhD theses. You can do a lot with these details: for instance, answering the following questions:
1. how has the average forecast of the first policy tightening evolved in terms of timing and size in comparison with the previous forecast?;
2. is there a correlation between this evolution and data published subsequently?;
3. is there a link between FOMC members’ speeches and individual forecasts (“who endorses which forecast?”);
4. do we need to worry when the individual forecasts range more widely?;
5. when there is a significant discrepancy between the average forecast and what Ben Bernanke says, does this mean that his credibility is at stake and that his position could be undermined?;
6. when the profile of the projected fed funds rate is steep (i.e. when FOMC members predict a rapid series of rate hikes once the first step has been taken), should we be reassured that this path reflects the Fed’s confidence in the economic recovery, or should we be worried that the Fed is agonising over inflation?;
7. analogous questions can be asked if the interest rate profile is very flat: does the Fed believe that the economy will remain weak and will not respond to the accommodating policy, or is the Fed worried about deflation?

In short, more than enough questions to fill up many analysts’ report, but as an investor you will not be much wiser. Bernanke was asked the key question at this week’s press conference: how confident can one be about forecasts for several years down the line? His response spoke volumes: “Our ability to forecast three and four years out is obviously very limited”. You wonder why anyone even bothers to publish individual forecasts over such a time frame.

I have the feeling that Bernanke was worried that the market might be unsettled by the wide spread of the forecasts (from three FOMC members who are thinking about a rate hike this year to two others who would not raise rates before 2016 (!)). Hence his message that the fed funds rate would remain unchanged until late 2014. If we link this to the longer-term inflation target of 2%, the message, although implicit, is crystal-clear: for those who have debts, inflation will gradually reduce them; and for those who have money to invest, they can choose between paying an “inflation tax” (because interest rates are below inflation) or taking more risk.

No wonder that the emerging country currencies surged on the day after the FOMC meeting.

William De Vijlder
Chief Investment Officer, Strategy & Partners
BNP Paribas Investment Partners

27 January 2012

Risk aversion fatigue

Text published in Le Jeudi (Luxembourg) on 26 January 2012 and in Beleggers Belangen on 27 January 2012.

Client meetings in the past few days in Paris, Helsinki and Vienna had already made me suspect a certain degree of ‘risk aversion fatigue’ among investors, and recent market movements confirm this impression. Various factors explain this phenomenon. For one thing, the current attitude towards the Eurozone is one of ‘no news is good news’. In fact, potentially alarming news is shrugged off. Rating downgrades for numerous countries? No problem. Germany is reportedly not keen to increase the EFSF funding? No problem. And the list goes on. One explanation is undoubtedly the growing awareness that the European Central Bank made a very intelligent decision in pumping almost EUR 500 billion of liquidity into the banking system for a three-year period: banks can use the facility if they are unable to refinance their debt paper at maturity or to buy government paper. And what do we see now? Investors are perfectly prepared after all to invest in bank paper and the auctions of government paper in France, Italy and Spain went quite smoothly. In this light, the prospect of a new ECB three-year funding operation in February sounds as music to the ears.

Another contributing factor is the feeling that the US economy is not in as dire straits as thought. Unemployment is falling, more jobs are being created, small businesses are becoming more upbeat, confidence in the construction sector is improving. If it goes on like this, the current consensus forecast of 2.1% growth for this year will need to be revised upwards. The pessimism of last summer when many feared a new recession is already a distant memory. Interestingly, since last summer the US indicators have systematically surpassed the expectations: despite the overwhelming amount of data, predicting the economy remains a hazardous business.

The emerging picture looks very different from what was deemed possible between Christmas and New Year, when the mood was still doom and gloom. Now it would seem that bad news such as certain corporate results or the relentless rise in oil prices due to the weaker euro has no significance. So the problems have by no means disappeared, even though the newspaper coverage has become less intense. Undoubtedly, the traditional seasonal effect is also playing a role. The equity markets tend to do better in January than in most other months, as many investors think in calendar year terms: they avoid risk towards the close of the year if the results are good at the end of November and start building up risk positions at the beginning of the year when they can start all over again with a clean slate. There is, incidentally, an interesting asymmetry in this respect. When stock markets rise, the expected future return falls, because good news has already been priced in. So what you don’t want at the start of the year is to fall behind the pack, because that means you need to pedal twice as fast to catch up (‘twice as fast’ refers to the fact that the expected future return has meanwhile decreased). If the stock markets fall at the start of the year, you can reduce your position via a price limit and find consolation in the consideration that the expected return has increased (because markets typically fluctuate more strongly than the fundamentals). So for now, let us all enjoy the January effect and prepare ourselves for the European summit at the end of this month, which will no doubt provide a timely reminder of the challenges still awaiting us.

William De Vijlder
Chief Investment Officer, Strategy & Partners
BNP Paribas Investment Partners
19 January 2012