“The economic recovery has continued at a moderate pace in recent quarters despite the strong headwinds created by federal fiscal policy,” was Ben Bernanke’s opening line when delivering what is expected to be his final testimony before the often unpredictable US congress on Wednesday. Only if congress was smart enough to realize he was taking a shot at them. But as his testimony continued, he seemed to create a bit of a wobble in the markets, only to see them in turn trade higher as he reaffirmed the point that the fed intends to slow asset purchases this year should the US economy continue to grow stronger.
The main point of Bernanke’s testimony, and it is a central one that many continue to miss, is that US monetary policy is not on a predetermined course. While many are expecting the US Fed to begin to “taper” come September, they will only do so should the economy continue to show signs of improvement. It is strictly the data that drives the decision making for the Fed, and not what many believe to be the intuition of a bunch of policy wonks at the central banker.
That being said, this is particularly why Bernanke still sees easy monetary policy going forward as unemployment is still high and only making its way down gradually. And as gradual and moderate have probably been the most frequently used adjectives out there to describe this recovery, they speak to the point that improvements in the US labor market have been anything but robust.
The other roadblock continues to be that the measured level of inflation is under their targeted level, so in this regard there is no pressure to tighten monetary policy. Not only would tightening be premature, but also it almost becomes too restricting or unproductive. Albeit, as asset purchases may indeed slow from the US Fed, they continue to provide the forward guidance to let creditors and borrowers know that interest rates will stay low until at least 2015.
The explanation of the Fed’s policy approach highlights the three distinct policy tools in which they may interact in the economy: asset purchases (QE), setting interest rates (the Fed Funds Rate), and forward guidance (offering insight into policy direction). And despite the media not often being able to differentiate between the three, the Fed continues to present their objectives, which carry implications for the financial markets. It is the notion of forward guidance, however, that despite not being a substantive tool in the sense that it does allow the Fed direct interaction into the financial markets—it seems to have the most impact.
Forward guidance offered by the US Federal Reserve affects the market in what might be thought of as fed induced volatility. To the gold market, we know it as “buy the rumour, sell the news” because it was the announcement of a new policy of increased treasury purchases that created the catalyst for a rally, instead of the actual event.
For many investors who bet on the failings of a US recovery, we seemed to have hit a roadblock. To reference back to the opening sentence borrowed from Chairman Bernanke’s testimony, fiscal policy has been the biggest drag on the economy. However, that being said, the economy is improving. The US Fed utilized imperfect tools to try and assist in what seemed to be a hopeless task. The problem is financial markets don’t seem to worry about patching a hole in the roof when the sun is shining. We can talk all we want about how doomed the US social safety net programs are and how dysfunctional their system of governance is, but ultimately we’ll have to wait for the repercussions until it starts to rain again in the markets.