There is an awful lot of talk coming out of the Fed just at the moment, and the market is trying to weigh up all the nuances of The Chairman`s speech, the FOMC minutes and individual comments by committee members whilst trying to compare this new input to Ms Yellens answers just a week ago. The purpose being to understand what subtle change in message may be underway.
As readers know, my patience with this process is wearing thin. I think it has been very clumsy of the Fed to get itself into this situation, and their obvious indecision will not have flattered judgement of the last part of Mr Bernanke`s chairmanship. Communication, as judged by the September debacle, has not been great, but I assume the greater harm was at the time deemed to be a reduction of stimulus as figures weakened. The real essence to the Fed`s quest, and indecision, is clear – how to square the circle between announcing a taper, whilst at the same time, managing the yield curve. I think that the sharp rise in long term rates in May/June when the botched attempt to prepare the market for a taper, really scared them, but the debate in the Fed has now moved on to discussion relating to what further effect at the long end will a taper actually produce. My guess, and their conclusion I think, is that it is inevitable that the 10 year yield will go above 3% when the process starts, but will settle not too much beyond that. No reason there not to taper in December/January in my view (because simply, I don`t know when a guaranteed better time will be!), but every reason to reinforce a campaign to manage shorter term interest rate expectations.
That is why we have seen in the Chairman`s speech, an emphasis on the Feds desire (and need) to keep interest rates along the curve as low as possible, and not to link any taper to a premature rise in interest rates. Just how credible they are judged to be in this objective will be crucial. Ms Yellen has a challenge in front of her that will not be tolerant of indecision. The numbers are coming in nicely; lately we have seen consumer spending and retail sales up. Her dovish nature must not stand in the way of a process that must end – and the sooner that is underway, the sooner the focus can be placed on what is really important – managing expectations relating to the Fed funds rate, and maintaining low interest rates for as long as possible.
So in summary, I think that Ms Yellen`s emphasis must be to communicate better than Chairman Bernanke, to have a clear message about Fed funds, to demonstrate that she has a clear, measurable strategy, and above all, not to delay a taper simply because of fear of the inevitable repercussions.