(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
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