One Wednesday in Washington, Federal Reserve Chairman Ben Bernanke presented congressional testimony that repeated, virtually word for word, statements about US monetary policy he has been making since last September.
The Federal Reserve, Bernanke said, would continue buying $85 billion of bonds monthly until it was confident of reducing unemployment to 6.5 per cent. The scale of these purchases might be increased or diminished, but only if and when such shifts were warranted by economic statistics. Now, he said, there is no case for a change in either direction.
The reaction to this tediously familiar statement, which was followed by publication of the equally repetitive minutes of the last Fed policy meeting, was some of the wildest gyrations seen in the world’s financial markets for months.
As Bernanke spoke, Wall Street soared to its highest level ever, since the Fed chairman had clearly contradicted speculation about an early tightening of monetary policy. An hour later, however, prices slumped far below their opening levels, as the speculation of tightening revived among investors who claimed to read new meaning into Bernanke’s familiar phrases.
The speculation spread to Tokyo the Thursday after. Markets there had their biggest one-day swoon since the 2011 tsunami. By the end of the day, tens of billions of dollars in Tokyo and New York had probably been redistributed among speculators who had put different interpretations on Bernanke’s words.
Why did the financial world react in this manic-depressive way to a statement that was bland and predictable? Why do investors keep gambling vast sums of money in speculations on changes in monetary policy when Bernanke has tried to make crystal clear that significant changes are unlikely, at least until the end of the year? Given this unusually clear guidance, why don’t investors just forget about monetary policy, at least until autumn, and focus instead on economic fundamentals or corporate financial results?
Some investors may genuinely not believe Bernanke’s message. They may be paying attention to the small number of Fed officials, including Philadelphia Fed President Charles Plosser, who disagree with the chairman’s unlimited monetary stimulus. But we know these dissidents play no serious role in monetary decisions. So their followers in the market must surely be few and far between.
The other possibility is that many investors may rationally understand that the Fed will stick to its current course, but still hope emotionally that its policies will change. Is it possible that investors who stake billions of dollars on monetary assessments would allow themselves to succumb to wishful thinking? The answer seems to be yes, for several distinct reasons.
Some of Bernanke’s intellectual opponents are so appalled by what they see as the evils of printing money that they just cannot believe this policy will continue much longer, though none of the dire prophecies of hyper-inflation, dollar debasement and general financial mayhem have materialised.
Others have political or business reasons for hoping that Bernanke will abandon his monetary experiments and that the Obama administration’s entire economic policy will be seen as a failure. But probably the biggest group of Wall Street doubters are people who want to see the Fed reverse its policies because those policies have been too successful, at least in one respect.
By boosting stock prices far more powerfully than expected, the Fed has left many investment managers far behind. The average hedge fund this year, for example, has delivered only one-third the gains of a simple indexed stock market investment, trailing the performance of the S&P’s 500 by 10 percentage points. Feeling flat-footed and embarrassed, these investors are not just disappointed, they are indignant about a bull market they failed to anticipate. Rather than blaming themselves for this failure, they cite the Fed’s “market manipulation.”
How could professional investors, frustrated and angry though they may be, allow themselves to be guided by wishful thinking instead of objective analysis, thereby risking financial ruin? A possible answer is what psychologists call transference or the unconscious projection of one’s own feelings and ideas onto others and vice versa.
Many people on Wall Street who find soaring stock market prices upsetting imagine that Bernanke must be upset, too. They simply ignore Bernanke’s repeated statements, most recently before Congress, that the Fed considers current stock prices to be “not inconsistent with the fundamentals.”
Instead they assume that Bernanke must know, deep down, that Wall Street is experiencing a monstrous bubble. Because that is what they themselves feel.
Another form of transference works the other way. When Bernanke says something investors do not like to hear, for example, that the Fed is pleased with the outcome of its current policy and inclined to leave well alone, they overlay what they hear with a more appealing message they hear from people who can supposedly discern the Fed’s hidden agendas.
These people are the “Fed watchers” and Washington analysts employed by banks, investment institutions and media outlets to anticipate and explain the twists and turns of monetary policy.
These experts make up a respected lobby whose overwhelming interest is to convince the world that economic policy remains unpredictable and unstable. After all, it is hard for a Fed watcher to justify a big salary if all he does is tell his clients: “Nothing much is going to change for the rest of the year.”
The last thing these experts want is for Bernanke to be believed when he promises to carry on with an unchanged policy. And people wrong-footed by the Fed’s actions are eager to believe these expert speculations about policy changes.
At some point, of course, monetary policies really will start to change. But the timing of this crucial event will be determined by economic statistics, not by speeches and committee minutes.
The Fed will probably want to see six months of strong employment and at least two quarters of 3 per cent GDP growth before it seriously considers tightening. In the meantime, big market reactions to comments from the Fed chairman will mostly be reversed, expensively for those investors who replace analysis with wishful thinking.