In Fed We Trust
At this point, does anyone believe the Fed is willing to do anything that might really spook markets?
During the 1990s, back in the days of "Maestro" Alan Greenspan, it was widely believed that investors should pay careful attention to every word uttered by Fed chairment for clues as to where Fed policy was headed in the near future.
Did Greenspan seem to favor higher interest rates, or was he keeping the money spigots open for the foreseeable future? If it looked like there was no threat of rising rates, then the markets responded bullishly. Monetary policy in that era will still easy-money oriented, historically speaking. But, the target rate did rise above six percent at times, so when the Fed chairmen talked about "tightening" there might at least be some mild rate hikes on the horizon.
Market fear of Fed tightening appears to have lasted even until 2013 with the so-called "taper tantrum." In May of that year, the Fed announced it would begin cutting back on its purchases of bonds and mortgage-backed securities in an effort to move toward more normal monetary policy.
It was by no means a radical change, and the Fed certainly wasn't about to significantly cut back its huge portfolio that it had amassed in the wake of the financial crisis to keep asset prices high.
Nevertheless, the market did indeed throw a tantrum in 2013 in the form of a large sell-off in bonds causing yields to skyrocket over a period of months. In the end, the taper did not signal any sort of meaningful "normalization" in monetary policy, nor did it bring about a return to more ordinary target interest rates. Wall Street went back to business as usual.
By late 2015, we were hearing regularly — now from Bernanke's replacement Janet Yellen — that the Fed would "soon" be raising target interest rates and cut back the Fed's huge portfolio. By early 2017, though, all the Fed had managed to do was raise the target rate to slightly above one percent. The balance sheet remained untouched.
It seemed the market was learning to face the Fed's regular threats of "normalization" with healthy amounts of skepticism.
After eight years of making empty threats about rate hikes and portfolio sell offs, the markets are now receiving the Fed's latest proposed "unwind" of its balance sheet with mostly yawns.
As of October 2017, stock markets continue to soar, and there' been no sell-off in bonds as occurred in 2013. In other words, as the Fed increasingly talks about its unwind, markets seem unplussed, to say the least.
One investment analyst quoted in MarketWatch, Peter Boockvar, called the investment world's lack of areaction a "delusional" complacency, although it's hard to blame the markets for doubting that any big changes will happen.
So far, the Fed has given little indication that it's willing to do anything to upset the apple cart. After all, in recent years, after numerous quarters of claiming the market was growing and fundamentally sound, the Fed proceeded with only the tiniest movements on target rates. All while not touching its balance sheet. It's been nearly nine years since the Fed launched the new era of "unconventional" monetary policy. At this rate, it will take another nine years before target rates and the Fed's balance sheet approach even anything that might remotely be called normal.
So why should markets be spooked? If one had to guess what the Fed is really going to do over the next few years, this is as plausible a scenario as any: the Fed will continue with only the tiniest changes to its balance sheet and the target rate. If any negative macroeconomic news shows up, the Fed will announce a need for "caution" and cancel any plans at the unwind or in raising rates. When the next recession hits, the Fed can be sure to cancel all plans for tightening, and it may even throw in a few bailouts to to make sure Wall Street doesn't have to endure too much pain.
For many in the financial media, and in the pundit class in general, this too-scared-to-act routine from the Fed strikes many commentators as a type of wisdom in which the Fed slowly and deliberately calcultates all the scenarios and procedes with an almost preternatural understanding of what's really going on.
But there's no special knowledge at work here. What we're witnessing is simply a central bank that's too afraid to do anything, portrays it's lack of actions as calculated prudence.
Desperate to believe that someone knows what's going on, the financial media, DC politicians, and Wall Street investors are playing along.