con·sid·er·able

1. Worth consideration; significant

2. Large in extent or degree

Merriam-Webster

It was six years ago this month that the Federal Reserve cut the Fed Funds rate to its current target range of 0 – 0.25%, essentially cutting the interbank lending rate to zero. The upper end of that range hasn’t been a problem, as the effective rate has been falling since the rate corridor was introduced and hasn’t budged above 0.10% in quite some time. For that matter the lower end of the range doesn’t matter much either; there is not a lot of activity in the Fed Funds market and probably won’t be for some time, a considerable period one might say. A big part of the Fed’s economic growth strategy over the last couple of years has been forward guidance regarding this rate, fearing that any sudden, unexpected moves might spook the beast.

Now comes word, via several articles in the WSJ by none other than the Fed’s presumed favorite mouthpiece Jon Hilsenrath, that the Fed is considering dropping the “considerable period” phrasing that has been a part of their periodic statements for, well, a considerable period. Apparently, the Fed is even afraid that not warning the market that it may warn the market might cause a considerable change in the market it is trying to warn. Considering the consequences of such an inconsequential change has caused considerable angst at the Fed about how ambiguously ambiguous their statement about future rates should be considering that rates have already been low for a considerable period. If you understand that last sentence, you may very well be considered qualified for the job opening created by the announcement last week that Narayana Kocherlakota, the President of the Minneapolis Fed, will not seek a new term when his current term expires in 2016. He is, apparently, considering his considerable options.

Considering the movements of the bond markets last week, the Fed’s considerable concern regarding the language of their statement at the conclusion of this week’s FOMC meeting would seem overwrought and considerably less important than they presume. The Fed may have considerable control over the Fed Funds rate but their ability to exercise control over other markets is considerably less. Long term Treasury rates are set by the market and have wandered considerably from the Fed’s preferred path with both inflation and nominal growth expectations falling, yes, considerably since the end of QE. The Fed may be intent on raising rates next year but the bond market is saying that maybe they ought to reconsider any considerable changes.

The Fed has, in my opinion, been trapped by its own considerable emphasis on language as its preferred policy. The Fed’s word and phrasing choices now have become as important as actual changes in policy. The Fed doesn’t need to raise rates; merely to hint that it might consider doing so is tantamount to enacting the policy. Bond markets move now not on the dregs left in the teapot of open market operations as they once did but rather on the discussion that takes place while the tea is steeping. Any actual change in policy will have already been priced into the market by the time the policy is enacted. There are no surprises anymore and despite what the Fed and the stock market believe, that gives the Fed less, not more, power over markets.

Of course, markets have always anticipated policy changes but the ambiguous nature of future policy produced a trepidation, a degree of uncertainty in markets that doesn’t exist today. Because the Fed today is so careful about telegraphing future policy changes traders are free to operate with little fear of the Fed. That lack of fear leads to crowded, leveraged trades and more fragility in financial markets than was the case in years past. The Fed believes that by telling the market what they plan to do, markets will adjust gradually as the policy change approaches. Unfortunately, for that to work, the Fed’s economic forecasting has to be perfect, a standard they have failed to achieve by a considerable margin. What happens when the Fed signals a policy change that is rendered unnecessary by their own signaling?

The Fed started to prepare the market for rate hikes as far back as the spring of 2013, the so called taper tantrum. By doing so, they produced an immediate change in interest rates as the market repositioned – violently and rapidly, not gradually – for the change in policy. The change in the market – higher interest rates and a stronger dollar – produced changes in the economy that may – I think will – make the policy change the Fed telegraphed unnecessary. Higher rates last year caused a collapse in the mortgage market and an economic slow down that culminated in a negative GDP print in Q1 2014 (no, it wasn’t all weather). Now a higher dollar is causing a crash in crude oil prices that, if it continues, threatens one of the few industries that has thrived since the crisis. In other words, the Fed’s threat to tighten policy produced the same effect an immediate rate hike would have produced.

Now, having telegraphed a need for higher rates, a confidence in future growth, the Fed may not be able to implement the policy they told the market to expect. Traders have been wrong footed by the Fed they trusted. With almost everyone positioned for higher rates – short long term Treasuries – the market has moved in the opposite direction. The Fed’s implicit forecast for better growth is being derailed by their own words. Bond yields are in a free fall along with inflation and growth expectations as traders unwind the trade the Fed’s language told them would be profitable. The other market most affected by the Fed’s signaling, the dollar, hasn’t yet reacted to the change in growth expectations but my guess is that it will soon join bonds in recognizing that the Fed’s plan has been derailed by its own effort to avoid being hoisted on its own petard.

I don’t know whether the Fed will change its statement next week and excise the reference to rates staying low for a considerable period. I do believe that events set in motion by the Fed’s own forward guidance have eclipsed the need for the policy itself. Changing the language at this point means little although it may still produce changes in the markets. Stocks are the last market that still seems to believe the Fed will not only raise rates but have a reason to do so. That may have started to change last week as the drop in oil prices became too large to continue blaming on just an increase in supply and interest rates plumbed new depths. If the Fed feels compelled to follow through with the rate hikes they say are coming, the bond market is saying the result will be lower inflation and more importantly lower growth. Lower growth from here may be indistinguishable from a recession, which may produce another considerable period. I suspect when future economists look back on this time, they will see it as very worthy of consideration – as a warning about the hubris of central bankers who thought they could fool the market with mere words.

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