“You can’t tell the players without a program. Get your program here!” yelled the stadium vendors of my youth. In today’s Outside the Box I bring you an excellent piece of Fed watching by Nouriel Roubini and colleagues, a “program” of the new Fed members and where they rank on the hawk-dove scale. They point out that, with a new chairperson (Janet Yellen) and vice-chair (Stanley Fischer), and with higher than normal turnover on the Federal Open Market Committee (FOMC) – over the past year, 75% of the FOMC’s membership has changed – the Fed’s need for clear communications with regard to monetary policy and forward guidance is greater than ever.
And it’s not as though the Fed has wielded its powerful communication tool with perfect aplomb in recent years. Last year at about this time, you’ll recall, we were in the midst of a frightful hullabaloo when the Fed threatened to release upon the world the Dread Taper … and then changed its mind. And then this past March, just as everybody was learning to live with the Taper, Yellen went to the mike and attempted to explain the Fed’s statement that the federal funds rate would remain near zero for a “considerable time” after QE ended. That meant interest-rate hikes could happen “in about six months,” she allowed – and all hell broke loose. Again.
And then there’s this whole business of FOMC members speaking out of school. We didn’t see much of that during Greenspan’s reign, which our authors characterize as being “close to an absolute monarchy,” but Bernanke took things in the direction of a collegial democracy – and paid a price for being nice. Yellen is similarly inclined – indeed, as our authors note, she has been at pains to ensure that her expressed views are close to those of the FOMC majority (which is decidedly dovish, yet not so dovish as Janet herself). So we may be treated to further instances of regional Fed presidents popping their heads up here and there around to the country to share their innermost feelings in the wake of official FOMC statements.
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I think you’ll agree that the following piece brings us up to speed about as painlessly as possible on all things FOMC – I enjoyed it, and I think you will too.
I have spent the last three days with Christian Menegatti, the managing director of Nouriel’s research firm. We have been in nonstop meetings and presentations (and dinners!) with a wide variety of businessmen, bankers, hedge fund managers, central bankers, government officials and ministers (even an off-the-record talk with a person from the Vatican Bank). Quite the whirlwind. I will readily admit that I’m surprised at what I have learned. I brought the expectations from my reading and my previous numerous trips to Italy, but I found out that things are now different here for the first time in a VERY long time. This week’s letter, which I will write in Dallas on Friday, will give you the details. For what it’s worth, Christian, who grew up in Italy but has been in New York for the last 14 years (or so), was also surprised. We spent a lot of time animatedly discussing what we learned and what it means for Europe and the world. You’ll want to read this one.
I spent nine hours on Sunday on a very aggressive walking tour of Rome. John Noronha is perhaps the most knowledgeable and enthusiastic guide I have ever had on any tour anywhere. He is a polymath with multiple technical and artistic and theological degrees, and he seemingly remembers everything he has ever read. In the process of seeing the major tour sites, we stopped at this or that church that happened to be “on the way” and that had a Raphael or a Caravaggio or two or three. The art I saw on the day was better than in all but a few museums I have ever visited. Billions of dollars’ worth of art and no guards. I was actually allowed to touch a Michelangelo sculpture (what museum will allow you to do that?), and I swear you could feel the bones and ligaments underneath the marble. I mean I could feel details that my eyes could not see. I was in awe for the rest of the trip. We must have toured nine churches (“We simply have to stop to see thi s one!”) and John knew every artifact in each of them. At a few points I actually tried to stump him with a question about some arcane object, but he assumed I was truly interested and launched into detail about the history of object after object. As good as he was, he could not organize the weather, and the rain came down in sheets at the Coliseum. But the double rainbow after was a perfect end to an exhausting but memorable day. (I think John doubles as a personal trainer.) If you are ever in Rome, you should get him to be your guide and make him bring his wife to dinner. She teaches communications at the Vatican. You can contact him at www.johnandashley.org.
And for those who asked, the website of the villa where we stayed in Tuscany is http://www.ifiordalisi.com/ . It was my fourth time to go there and spend a few weeks. It is a perfect base to tour Tuscany and the surrounding regions.
It is time to hit the send button. My flight back to Dallas will leave from Rome in a bit. Have a great week!
Your going to miss the food analyst,
John Mauldin, Editor
Outside the Box
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Musical Chairs at the FOMC
By Nouriel Roubini, Sheryl King and Prajakta Bhide
Roubini Global Economics
May 29, 2014
- Communication is one of the main tools at the Federal Reserve’s disposal in what will soon be the post-QE, post-Evans rule era, making it critical to assess the Fed’s ability to deliver a coherent monetary policy message. Even in normal years, the FOMC struggles to deliver a clear view about the economic and policy outlook as its voting members rotate so frequently. Here, we analyze the communication challenge presented by the significant turnover of FOMC members, exploring the views of individual members and assessing the implications for core policy decisions.
- Bottom line: While the mean FOMC voter is more hawkish this year than in 2013, the view of the median FOMC voter – more important for decisions – has not changed much. However, there is still some potential for market volatility induced by disparate and relatively unknown voices at the Fed, particularly with regard to the new vice-chairman, Stanley Fischer. We believe that Fed Chair Janet Yellen, a consensus-builder with a solid grasp of the Fed’s communication challenge, will be largely able to counter individual hawkish noises. Still, delivering a clear forward guidance message under these circumstances will be tricky during a critical period of policy normalization. Ultimately, we believe Yellen’s dovish views will prevail, but Fed communication and forward guidance may become less explicit.
- Market implications: We do not expect a repeat of the bond-market gyrations experienced last summer, when the Fed signaled the launch of QE tapering and then did not deliver, but increased market volatility around Fed communication is a risk. As the central FOMC view is dovish, the risks are skewed toward sudden jumps in Treasury yields and equity market sell-offs on market commentary from new Fed speakers, particularly Fischer and some of the new hawks in the FOMC.
High FOMC Turnover Makes for Mixed Messages
In the post-Evans rule era, the Fed’s policy approach has returned to a more discretionary one, with no clear explicit or implicit policy reaction function upon which markets can draw. In recent years, the Fed’s communication strategy has been anchored by QE. But with QE set to end by Q4 2014, the Fed will no longer possess this quantitative policy tool.
Until such time as the Fed decides to take a policy measure again (mostly likely to be a hike in the policy rate), the policy stance will be one of watchful inaction, with the Fed and policy-watchers scanning the incoming economic data for signs that higher policy rates are warranted. In this vacuum, the Fed will rely heavily on communication, enhanced perhaps by a reverse repo facility and/or a term deposit facility intended to keep short-term interest rates anchored. With so much riding on communication, the potential costs of miscommunication are that much higher. (The turmoil in financial markets last summer – when the Fed botched the taper signal, sparking a “taper tantrum” – is a clear example of said costs.) Once the first policy rate hike occurs (perhaps sooner), the Fed will have to communicate to the markets what its likely policy reaction function will be with regard to the speed and pace of policy rate normalization.
In this context, the substantial churn in the composition of the FOMC of late merits close attention. Over the past year, 75% of the FOMC’s membership has changed – more than twice the normal rate. With so many new faces joining the committee, delivering clear policy and forward guidance will prove tricky – especially as the Fed exits QE and looks toward policy rate normalization. Fed Chair Yellen expressed it bestwhen she said that effective forward guidance “…depends critically on [the Fed’s] ability to shape expectations of the future, specifically by helping the public understand how it intends to conduct policy over time, and what the likely implications of those actions will be for economic conditions.”
Delivering the message in a clear and consistent manner is always difficult for monetary policy makers. With a constantly changing roster of decision makers and varied views on how monetary policy should be conducted to achieve policy goals, the message becomes all the more muddled. At least four FOMC voting members, the Fed bank presidents, rotate on and off the board of governors every year, and governors on the Fed board rarely serve a full 14-year term, meaning that even in normal years the FOMC is susceptible to criticism regarding muddled messages.
The rate of FOMC-member turnover has been particularly high over the past year, which has seen the departure of three board members (Chairman Ben Bernanke, Sarah Raskin and Elisabeth Duke) and Governor Jeremy Stein, along with the retirement of Cleveland Fed President Sandra Pianalto at the end of May. As a result, three seats on the committee have changed in the past year, on top of the normal rotation of four of 12 Fed bank presidents per year.
The rotation in Fed presidents does not present too much uncertainty: Even non-voting members speak to the public regularly, so their views on the economy, markets and monetary policy are well known. However, the views of the other new FOMC members are much less familiar.
The FOMC: Known Unknowns
There are two