Excessive Fed watching is a bad sign
Stocks rose sharply Thursday, building on the previous session's late-day rally, with the Dow Jones Industrial Average retaking 11000 as traders cheered somewhat dovish remarks on inflation by Federal Reserve Chairman Ben Bernanke.This quotation is symptomatic of what appears to be an increased emphasis on Fed watching in recent months. It is hard to quantify, but financial markets seem to be extraordinarily focused on remarks coming out of the Fed and, in particular, on those by Ben Bernanke.
Perhaps increased Fed watching is inevitable whenever we have a new Fed chairman, but it is nonetheless troubling. Fundamentally, Fed watching is a symptom of ambiguity in monetary policymaking. Fed insiders do not have significantly more data on the economy than everyone else. When financial markets react to Fed statements, therefore, they are not incorporating news about the economy. Instead, they are incorporating news about policymakers' intentions. So if a speech or testimony by a Fed official moves financial markets, it means that the intentions of monetary policymakers were not clear before the speech or testimony.
Most modern monetary economists, including Ben Bernanke, are advocates of transparency in monetary policymaking. I agree. We can gauge how close we are to the goal of transparency by noting how much speeches and testimony of Fed officials move markets. Under perfect transparency, markets would react to Fed remarks with a yawn. Traders would say, "Of course, he would say that, given the data we have all seen lately. None of that verbiage changes my view about the course of monetary policy." Macroeconomic data would move markets; remarks by Fed officials would not.
The ideal would be a completely boring Fed chairman whose speeches are regularly ignored by financial markets. Apparently, we are not there yet.