Yesterday's comments by Ben Bernanke highlights the influence wielded by central bank commentary, but also exposes just how hollow the Fed's policies are becoming.
In trading circles, it is often said that you should 'buy the rumour, sell the fact' when referring to market psychology and short-term speculative trading motives. The idea is that markets initially fall or rise because of rumours/fears/exuberance and then fall back into line as the facts become known. It could easily be reversed i.e. 'sell the rumour, buy the fact'. This phenomenon very often occurs in equity markets as various M&A rumours, takeovers and other company news push up prices, only for the eventual fact to disappoint and reverse earlier gains. The same can be applied to any tradable market, including FX.Over the past few weeks, we've seen a protracted build-up of expectations that the Fed will start reducing how much capital it gives out to struggling banks - at some point in the future. All markets went into a tailspin, worried that cheap money was coming to an end. A vicious rumour indeed. The Fed soon realised that the comments made on June 19th and the expectations those comments formed were to a large extent overdone. Despite several Fed members making dovish comments over the past few weeks in an attempt to temper the market, investors were unconvinced. However, yesterday's blitz of dovish comments was a clear attempt to dissuade the market - and to a large extent, it worked. 'Open-mouth operations' are being deployed with greater frequency by central bankers who understand that when markets are becoming increasingly rumour-driven and speculative, the best way to reign them in is by playing to their weakness - a propensity to become fearful, anxious, panicked at a moment’s notice.
Highlights & Summary
Ben Bernanke was quoted as saying:
“Too early to say U.S. has weathered fiscal restraint”
“Inflation, jobs signal more Fed stimulus needed”
“Falling inflation can be bad for an economy”
“Overall thrust of policy is highly accommodative”
“..Very low inflation rate- committed to defending inflation target from the low side as well as the high side”Overall, the minutes and subsequent comments made by Bernanke were very dovish and the market reacted strongly.
The FOMC minutes were largely as expected and did not create more market volatility than would normally be expected. Bernanke's speech on the other hand, created a blitz of USD selling, equity market strength and plummeting yields, across the whole US yield curve. Both short and long term US bonds were speculatively bought up as investors realised the buyer of first resort (The Fed) isn't going anywhere and will continue to prop up the bond market first and foremost. Equities, USD and commodities tend to follow suit.
Market Reaction
Looking at the knee-jerk reaction of various FX pairs yesterday, it’s clear that Fed influence is as strong as it ever was despite nothing actually changing. Fed asset purchases stand at $85bn per month and will continue to be carried out for at least another 2 years if not more. Despite this, investors were quick to price in tighter monetary policy thus forcing all asset classes into a wild goose chase after the Fed misspoke on June 19.
As we discussed in our articles ‘Quantitative Hardening’ and ‘The Fed has pencilled in a shift of QE policy - but can the markets bear it?, the Fed is not going to reduce asset purchases despite the tough talk. Asset prices rely on the Fed. Capital markets rely on the Fed. Bond prices have been artificially supported by the Fed. Removing QE would be like removing the drug that is keeping a terminally ill patient alive. The Fed knows this but must continue to play a game of cat and mouse with market participants that have disengaged from facts, fundamentals and reality. This may be difficult for some to contemplate but the financial markets are seeing intensive market manipulation, market planning and centralised decision making. Capitalism is alive; it’s just being administered by the state.
As the dust settles, market participants, traders, analysts and mainstream media will now scramble to speculate on the likely timing of Fed QE slowdown, the timing of when purchases will hit zero, how long the Fed will pause and when the Fed will remove the excess capital created. Expect many up’s and down’s as Fed plays cat and mouse with speculators. Keep in mind how the markets reacted to the mere suggestion of QE removal and consider what ACTUAL QE removal could do. Considering what we've seen between Bernanke’s Q/A on June 19 and his Q/A yesterday, maybe traders should add another trading axiom to the list: ‘Ignore the rumours, buy the facts’
