Central Planners Alleged to Have Higher Tolerance for Market Volatility
Bloomberg informs us that the new broom at the Fed, Janet Yellen, won’t immediately rush to the stock market’s aid when the next downturn comes. Could it be that an article from the Onion has been smuggled in while they were not looking? Lately, Fed doves have been wheeled out at every market dip exceeding 3%. The shrinking contingent of haws (such as Charles Plosser) is usually only allowed to hold forth on weekends.
A few excerpts from the Bloomberg fantasy on the miraculous change in central planner focus:
Janet Yellen is leaving the Greenspan “put” behind as she charts the first interest-rate increase since 2006 amid growing financial-market volatility.
The Federal Reserve chair has signaled she wants to place the economic outlook at the center of policy making, while looking past short-term market fluctuations. To succeed, she must wean investors from the notion, which gained currency under predecessor Alan Greenspan, that the Fed will bail them out if their bets go bad — just as a put option protects against a drop in stock prices.
“The succession of Fed puts over the years has led to a wide range of distortions in financial markets,” said Lawrence Goodman, president of the Center for Financial Stability, a monetary research group in New York. “There have been swollen asset values followed by sharp declines. This is a very good time for the Fed to move away.”
When Fed officials met in October, two weeks after the Standard and Poor’s 500 Index (SPX) wiped out all of its gains for the year, they discussed adding a reference to market turmoil in their statement. They rejected the idea to avoid the “misimpression that monetary policy was likely to respond to increases in volatility,” according to minutes of the meeting.
“Let me be clear, there is no Fed equity market put,” William C. Dudley, president of the New York Fed, the central bank’s watchdog on financial markets, said in a Dec. 1 speech in New York. “Because financial-market conditions affect economic activity only slowly over time, this suggests that we should look through short-term volatility.”
NY Fed chief William Dudley: there’s no Fed put, honest injun.
It’s OK. You can stop laughing now. Take a deep breath. So why is it supposedly no longer a problem if the market were to actually decline? Of course, there is a big “but”. Greenspan meanwhile wonders what this silly blabber is actually about, since monetary pumping in the face of market declines is, well, what the central banks does. Duh.
“Bolstering the Fed’s resolve is a banking system that’s more resilient to market shocks today than it was during Greenspan’s 18-year tenure that ended in 2006.
One lesson former Chairman Ben S. Bernanke brought to the Fed during the financial crisis, however, is that widespread aversion to risk amid financial panics can accelerate economic declines. Fed officials are committed to avoiding those incidents and now incorporate detailed analysis of financial-system risk into their monetary-policy discussions.
The Fed’s determination to look past market fluctuations could be tested as market rates defy the Fed’s prediction that the economy will warrant higher borrowing costs soon.
Greenspan, now a private economist, said in an interview that he regarded the notion of a Fed put as a “joke.” Cutting rates to add temporary liquidity to ease panicky financial conditions is what central banks have always done, he said.”
Ah, that “more resilient than ever” fractionally reserved banking system. We wonder if anyone recalls Hank Paulson declaiming sotto voce in 2007 that “the US banking system has never been healthier than it is today”? The system was in such ruddy health, it was de facto insolvent a year later.
In the end, we are being told that they might as well not have published the article at all, since the “Fed put” actually lives on. In other words, the article is just another in a long string of vapid assurances published in the mainstream financial media, asserting that the central planners have things well in hand and actually know what they are doing.
“Nobody thinks Yellen would ignore a severe bout of financial turmoil. The breaking point is when financial conditions begin to change the central bank’s forecast.
“The put is there — it is just further out of the money,” said Michael Gapen, chief U.S. economist at Barclays Capital Inc. As the central bank raises rates, “there could be more volatility and the Fed could be OK with it.”
One thing is absolutely certain: we will find out how much volatility they really are “OK with”. The current echo bubble in financial assets is one of the biggest in history, and hence fated to burst with a bang when the time comes (admittedly, it could well grow to even bigger size before that happens).
So far our impression is that even the smallest market dips are eyed with great apprehension by the monetary bureaucrats – how else can one explain the extremely judicious timing of assorted Fed members making dovish statements? It seems difficult to believe in coincidences in this context. If anything, the put seems to be almost an at the money one these days.
The most important take-away from such articles is actually not their specific content. In several respects it seems a waste of effort to even discuss whether or not the “Fed put” exists. For one thing, the central bank is powerless to arrest a market decline, unless it is prepared to destroy the currency it issues at a very rapid rate. Since we can probably assume that this is not the plan, there is nothing the Fed can do to prevent the market from falling when the time comes.
Secondly, it will nevertheless try to arrest a market decline, or at the very least open the money spigot so wide, that a significant decline is eventually retraced as the devaluation of money against titles to capital resumes. There is a variable time lag involved, but there can be little doubt that this is indeed in the central bank’s power. There is one important exception: if the damage to the economy’s pool of real funding ion the wake of a credit bubble is very severe, the market may actually decline in spite of excess liquidity being made available.
This leaves us to ponder what the purpose of such articles is, and we already hinted at it above: their aim is to bolster the impression that central planning of the economy is not only possible, but a perfectly normal and desirable state of affairs. Monetary interventionism by bureaucrats is to be taken for granted and to be accepted as delivering the best of all worlds. It is basically propaganda dressed up as reportage.