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Ben Bernanke is the most misunderstood man on Wall Street Ben Bernanke is the most misunderstood man on Wall Street
(3 months later)
When Federal Reserve chairman Ben Bernanke speaks, it costs you money. That's true whether you have a savings account, a mortgage, or money in the stock market.When Federal Reserve chairman Ben Bernanke speaks, it costs you money. That's true whether you have a savings account, a mortgage, or money in the stock market.
The housing recovery, for instance, is built on dubious premises, but let's say you ignore those and want to join the party by signing a 30-year mortgage with a fixed interest rate. Today, you'd pay a rate of 4.6% on every payment; last month it was only 3.88% and in November it was at a record low, 3.31%.The housing recovery, for instance, is built on dubious premises, but let's say you ignore those and want to join the party by signing a 30-year mortgage with a fixed interest rate. Today, you'd pay a rate of 4.6% on every payment; last month it was only 3.88% and in November it was at a record low, 3.31%.
On a mortgage of, say, $165,000, the difference between the current mortgage rate and the one in November is, very roughly, an additional $1,500 a year in mortgage payments.On a mortgage of, say, $165,000, the difference between the current mortgage rate and the one in November is, very roughly, an additional $1,500 a year in mortgage payments.
Why this cost? Here's the basic problem: for years, the Federal Reserve has had a chokehold on the very basic interest rates that rule the economy, keeping them down to nearly zero. That means that from now on, there's only one way direction in which interest rates can travel: up. There's a 100% chance that rates will rise; the only question is when. There's also a 100% chance that we will find out that rates will rise during a public statement by Bernanke. The result: every time Bernanke speaks, the markets assume that their rock-bottom interest rates will disappear imminently, and they sell their bonds.Why this cost? Here's the basic problem: for years, the Federal Reserve has had a chokehold on the very basic interest rates that rule the economy, keeping them down to nearly zero. That means that from now on, there's only one way direction in which interest rates can travel: up. There's a 100% chance that rates will rise; the only question is when. There's also a 100% chance that we will find out that rates will rise during a public statement by Bernanke. The result: every time Bernanke speaks, the markets assume that their rock-bottom interest rates will disappear imminently, and they sell their bonds.
Bernanke's hope is to communicate clearly with the markets – an honorable pursuit, in general – and he has been doing that. He has set very specific standards to let investors know when the Fed will raise its target interest rates: that will be around 2015, at a time when the unemployment rate is expected to hit 6.5%.Bernanke's hope is to communicate clearly with the markets – an honorable pursuit, in general – and he has been doing that. He has set very specific standards to let investors know when the Fed will raise its target interest rates: that will be around 2015, at a time when the unemployment rate is expected to hit 6.5%.
Bernanke has been brutally honest with the market, repeating his targets time and time again. And in return, the market has been brutally honest with Bernanke, with investors stomping out of the bond market at the slightest whisper of rising rates.Bernanke has been brutally honest with the market, repeating his targets time and time again. And in return, the market has been brutally honest with Bernanke, with investors stomping out of the bond market at the slightest whisper of rising rates.
In both cases, neither side is dissembling or misleading the other. But there's also a certain pain they hope to inflict on each other, hoping to manipulate the other side to come around to its own way of thinking. Bernanke wants the market to be prepared for the Federal Reserve to stop supporting its profits; the markets want Bernanke to know that investors will do anything to protect their profits, up to and including to hurting the wider economy.In both cases, neither side is dissembling or misleading the other. But there's also a certain pain they hope to inflict on each other, hoping to manipulate the other side to come around to its own way of thinking. Bernanke wants the market to be prepared for the Federal Reserve to stop supporting its profits; the markets want Bernanke to know that investors will do anything to protect their profits, up to and including to hurting the wider economy.
No one's lying, but no one's being cautious, either. As the British Conservative politician Richard Needham once said, "people who are brutally honest get more satisfaction out of the brutality than out of the honesty". That's where the relationship between Bernanke and the stock markets stand.No one's lying, but no one's being cautious, either. As the British Conservative politician Richard Needham once said, "people who are brutally honest get more satisfaction out of the brutality than out of the honesty". That's where the relationship between Bernanke and the stock markets stand.
So here's what we've learned from the panics of the past month: there's a value to vagueness. Bernanke shouldn't emulate the gnomic pronouncements of his predecessor, Alan Greenspan, who accomplished little more except clearing the runway for rampant bubble delusions. Maybe, though, it's time to acknowledge that the market is not a structure that can accept brutal honesty either. The more Bernanke speaks, the more he is misunderstood. This is amusing in a Cool Hand Luke kind of way – "what we have here is a failure to communicate" – until it does actual damage.So here's what we've learned from the panics of the past month: there's a value to vagueness. Bernanke shouldn't emulate the gnomic pronouncements of his predecessor, Alan Greenspan, who accomplished little more except clearing the runway for rampant bubble delusions. Maybe, though, it's time to acknowledge that the market is not a structure that can accept brutal honesty either. The more Bernanke speaks, the more he is misunderstood. This is amusing in a Cool Hand Luke kind of way – "what we have here is a failure to communicate" – until it does actual damage.
The market's nervousness about interest rates is whiny and petty, sure there's nothing sadder than men in charge of billions of dollars getting sulky because the Federal Reserve is going to force them to re-learn how to make money on their own. But it also has a real impact. Scott Minerd, the chief investment officer of Guggenheim Partners, described the dynamic of one such time that a market temper tantrum turned into an actual crash:The market's nervousness about interest rates is whiny and petty, sure there's nothing sadder than men in charge of billions of dollars getting sulky because the Federal Reserve is going to force them to re-learn how to make money on their own. But it also has a real impact. Scott Minerd, the chief investment officer of Guggenheim Partners, described the dynamic of one such time that a market temper tantrum turned into an actual crash:
"There are parallels between this event and the bond market crash of 1994 when then-US Federal Reserve Chairman Alan Greenspan increased the federal funds rate by 25 basis points. In the subsequent bond-market rout – the worst since the Great Depression – investors immediately began re-pricing bonds to where they assumed rates would be at the end of the tightening cycle, rather than waiting for interest rates to incrementally move to their new levels. Long-term rates doubled over the next six months and liquidity significantly dried up in the bond market.""There are parallels between this event and the bond market crash of 1994 when then-US Federal Reserve Chairman Alan Greenspan increased the federal funds rate by 25 basis points. In the subsequent bond-market rout – the worst since the Great Depression – investors immediately began re-pricing bonds to where they assumed rates would be at the end of the tightening cycle, rather than waiting for interest rates to incrementally move to their new levels. Long-term rates doubled over the next six months and liquidity significantly dried up in the bond market."
In short, when Greenspan raised rates, the bond market started a long, slow death. By the late 1990s, the bond market was a joke, which set the stage for bright young things to swarm into the stock market to make money. And make money they did, by inflating the dot-com bubble.In short, when Greenspan raised rates, the bond market started a long, slow death. By the late 1990s, the bond market was a joke, which set the stage for bright young things to swarm into the stock market to make money. And make money they did, by inflating the dot-com bubble.
It's great to be open, if you're in a trusting relationship, but there's also a value to playing your cards judiciously. Wall Street makes it money by being ahead of the game, by anticipating how stocks and bonds will move. The Fed is currently giving away the game by making predictions far into the future. It's like giving a wall calendar to a goldfish. Wall Street is a place of instant stimulus response, where speed and reflexes are prized, even more so than accuracy. No one on Wall Street thinks very far ahead; no grizzled bond trader is going to set an Outlook calendar reminder for 2015 to "watch out for rising interest rates".It's great to be open, if you're in a trusting relationship, but there's also a value to playing your cards judiciously. Wall Street makes it money by being ahead of the game, by anticipating how stocks and bonds will move. The Fed is currently giving away the game by making predictions far into the future. It's like giving a wall calendar to a goldfish. Wall Street is a place of instant stimulus response, where speed and reflexes are prized, even more so than accuracy. No one on Wall Street thinks very far ahead; no grizzled bond trader is going to set an Outlook calendar reminder for 2015 to "watch out for rising interest rates".
Instead, as soon as he has information, he'll start buying or selling as soon as he can. As Guy LeBas of Janney Capital Markets put it, "This is the financial markets. The Fed saying they're going to do something is no different from them actually doing it."Instead, as soon as he has information, he'll start buying or selling as soon as he can. As Guy LeBas of Janney Capital Markets put it, "This is the financial markets. The Fed saying they're going to do something is no different from them actually doing it."
The market is chaotic, unforgiving, and often utterly wrong as a predictive force. But it is dependable on one point: it will react to information as soon as it has it. Bernanke and his fellow Federal Reserve operatives should keep that in mind the next time they attempt radical transparency.The market is chaotic, unforgiving, and often utterly wrong as a predictive force. But it is dependable on one point: it will react to information as soon as it has it. Bernanke and his fellow Federal Reserve operatives should keep that in mind the next time they attempt radical transparency.
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