Tonight helicopter Ben gives a speech and the market is doing its usual thing and getting itself worked up for fireworks.
I’m starting to feel like the market will be disappointed.
The speech itself is “The first 100 years of the Fed: The policy record, lessons learned and prospects for the future”. It’s prepared text and is at the NBER conference. The title itself suggests that the majority of the speech is going to focus on history rather than the present but there will be a Q&A after and he could delve deeply into current policy.
Taking a brief look over previous speeches I’ve highlighted one from 2004 that may give some insight into how Ben could change tact and shape monetary policy. The speech was before the crisis and it will be interesting to see the differences if he broaches the same subjects.
The speech was titled “The Great Moderation” and focused on a decline in macroeconomic volatility.
Why has macroeconomic volatility declined? Three types of explanations have been suggested for this dramatic change; for brevity, I will refer to these classes of explanations as structural change, improved macroeconomic policies, and good luck. Explanations focusing on structural change suggest that changes in economic institutions, technology, business practices, or other structural features of the economy have improved the ability of the economy to absorb shocks.
Granted, I don’t think they were factoring such a shock as the one we got.
He also notes the importance of managing inflation expectations, the role of price shocks and the lack of effect currency fluctuations have on prices and economic activity, something we are seeing play out in today’s markets.
Monetary policy can also affect the distribution of measured shocks by changing the sensitivity of pricing and other economic decisions to exogenous outside events. For example, significant movements in the price of oil and other commodities continued to occur after 1984. However, in a low-inflation environment, with stable inflation expectations and a general perception that firms do not have pricing power, commodity price shocks are not passed into final goods prices to nearly the same degree as in a looser monetary environment. As a result, a change in commodity prices of a given size shows up as a smaller shock to output and consumer prices today than it would have in the earlier period. Likewise, there is evidence that fluctuations in exchange rates have smaller effects on domestic prices and economic activity when inflation is less volatile and inflation expectations are stabilized.
Certainly in the UK we are still battling commodity driven inflation and that has had an effect on companies reduced margins as they have found it hard to pass on the prices. The affect is slightly different in the US due to the lower inflation and import costs.
He finishes with his summation;
The Great Moderation, the substantial decline in macroeconomic volatility over the past twenty years, is a striking economic development. Whether the dominant cause of the Great Moderation is structural change, improved monetary policy, or simply good luck is an important question about which no consensus has yet formed. I have argued today that improved monetary policy has likely made an important contribution not only to the reduced volatility of inflation (which is not particularly controversial) but to the reduced volatility of output as well. Moreover, because a change in the monetary policy regime has pervasive effects, I have suggested that some of the effects of improved monetary policies may have been misidentified as exogenous changes in economic structure or in the distribution of economic shocks. This conclusion on my part makes me optimistic for the future, because I am confident that monetary policymakers will not forget the lessons of the 1970s.
So the question is how he sees things from the crisis to today. He’s been very hot on trying to keep inflation expectations anchored and is still fighting that battle with those that are waiting for an inflation explosion. He’s winning that battle slowly but that’s from the figures backing him up rather than a belief in his policy.
My summation of the speech tonight and how we possibly look to trade it
Expect the usual position squaring and jostling leading up to the speech.
The market, as usual, is looking for tapering clues and I don’t think they will get anymore that what he has already given. The likelihood is that he will re-iterate the party line which may put some disappointment in to the market. He may not even touch deeply on the subject and the market will also be disappointed by that.
My view is that we are more likely see the dollar fall tonight and that may give good levels to get in longs against the yen and shorts in the pound and euro. Should we get a shock then look to dip buy any decent falls in stocks.