There’s something to be said for surprise. It keeps us on our toes and makes life interesting. That’s especially true in financial markets, where we’ve grown accustomed to apparent certainties – from “consensus” earnings estimates to interest-rate forecasts. So it was good to see Fed Chairman Ben Bernanke remind everyone on Wall Street that Fed policy, like life itself, isn’t so easy to predict.
Sure, the Fed is caught in a box of its own design, having embarked on a plan of greater communication. But markets wrongly assumed that more communication meant complete clarity on the Fed’s intentions. It did not.
Anyone who bothered to listen to Mr. Bernanke should have heard that a slackening of the Fed’s stimulus – the artfully named “tapering” – was contingent on data that the economy was continuing to strengthen. No data support meant no tapering. Markets were caught off-guard, and Mr. Bernanke was immediately criticized for “playing with fire” when it comes to economic policy.
The right response from Ben Bernanke should be to borrow a phrase attributed to John Maynard Keynes when he was challenged about switching course: “When the facts change, I change my mind. What do you do, sir?” Markets crave certainty and mistakenly believe they can have it. That can be an expensive fantasy.
Of course, not every analyst was convinced that the Fed would start tapering now. Michael Hanson, a senior economist at Bank of America, got it right, saying he thought the Fed would not start tapering just yet.
This episode again shows that most folks on Wall Street want someone else to do their thinking for them. They chose to believe the herd about the Fed’s plan, rather than do their own analysis. Of course, they also believed that sub-prime securities were safe because they had triple-A ratings by the scribblers at Standard & Poor’s. And they believed what their risk models spat out regarding the value of complex trading positions. Some lessons are hard to learn, apparently.
The Fed’s move injected a bit of volatility into the market and caused outcry among traders and analysts, but it’s hardly the end of civilization as we know it.
Nor does it spell the end of the Fed’s open-communication program. It’s simply a reminder that while the Fed will offer more information it will not guarantee its future actions, no matter how bad Wall Street might want it to.