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Foreign Exchange

Confused by Fed monetary policy? Don’t be

The confusion over the Federal Reserve’s monetary-policy stance has heightened, as the central bank flip-flops between hawkish and dovish rhetoric.

Blame a breakdown in its communication strategy, but the market reacted by buying the dollar and selling risky assets on Tuesday after the minutes of the Fed’s mid-March policy meeting was seen as markedly more hawkish than the statement it put out after the gathering. Markets reacted as only two out of 10 voting members of the Federal Open Market Committee (FOMC) thought the prospect of a third round of quantitative easing (QE) could become necessary.

That came just days after markets priced in more QE after comments from Ben Bernanke, Fed chairman, last week that the pace of the decline in US unemployment might not be sustainable.

So what to make of Fed policy?

Firstly, it is clear that the FOMC has not turned into a group of hawks.

However, to understand the monetary bias at the central bank, it is necessary to look at the stance of all 10 voting members.

Handily, Merk Investments has done just that. The chart below shows there is just one voting hawk on the FOMC: Richmond Fed president Jeff Lacker.

 

If US economic data continue to beat expectations, then the hawkish bias will rise and the Fed will be tested by its commitment to keeping rates low until late 2014.

However, if US economic data enter a weak patch, which some expect, the odds are that the Fed will take out insurance against another slowdown and engage in another round of QE.

As Axel Merk, chief executive of Merk Investments, puts it: “In a world where everyone hopes for the best, but plans for the worst, central banks around the world – including the Fed – may keep the world awash in money.”

He notes that Bernanke has argued many times that tightening monetary policy too early was one of the biggest mistakes the Fed made during the Great Depression.

“We don’t think Bernanke will repeat this,” says Merk. “As such, when the dust settles, look at actions, not words. We see doves, not hawks, managing the monetary aviary.”

This article was originally published by EuromoneyFXNews.


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