The classic instructions given to a speech giver in a speaker's training course are as follows:
1. Say what you are going to say.
2. Say it.
3. Say what you said.
4. Say thank you very much, are there any questions?
In the last month, we have seen the failure of communication by the leadership of two central banks. Chairman Ben Bernanke gave a message that was obfuscated and misread by markets. His counterpart in Japan did the same. The result was turmoil in markets, increased volatility, and high uncertainty as measured by market-based indicators of risk premia. In the US, the interest rate on a home mortgage is now higher than it has been in months.
The result of their communications failure is a setback to the economic recovery. Here is an example. Somewhere, some prospective American homebuyer will not meet an affordability test to buy a house. The reason is simply that the mortgage payment will now be too high relative to the income that person obtains from his or her labor. Higher rates in the US Treasury note and bond markets create higher interest rates in the US mortgage market – that direct causality link is well established.
Similar events happened in Japan. We will not take the time to recount them here. They have been all over the news to the point of fatigue.
The two central banks did not want this outcome. Central bankers do not want to raise a risk premium if they are trying to restart economic engines and obtain growth. Their purpose is to focus on the recovery of their real economies. They understand that higher financial asset prices convey a positive wealth effect. Higher prices of real estate and other assets do the same. If you have a positive wealth effect while you are trying to stimulate growth, you get the benefit of it as an economic recovery ensues.
When you raise interest rates in the early stages of this process, before the economic recovery has achieved sufficient durability to be self-sustaining, you slow down the recovery and raise the risk of its faltering. In the last month, two central banks, the Bank of Japan and the Federal Reserve, have done just that.
Now we have media personalities attempting to convey indirectly that this policy of communication failure will be rectified. So, will it be corrected? Maybe – the markets seem to think so. The jury is still out until we hear it, read it, see it, and obtain clarity. The coming Fed meeting is the opportunity to find out.
Query: is media leaking the best repairing mechanism for failed communication strategy? We think not. Indirect media links to Mr. H or Mr. I or Mr. B only add to risk premia. They also create two classes of journalists and a lot of misguided perceptions by the general public. It would be much better for the central banks to get it “right” the first time.
Ben Bernanke and his colleagues could convey a straightforward message that delivers greater certainty to skittish markets. They could say, "We do not intend to sell assets or dump them on the market." That would eliminate this issue of selling out of these large central bank portfolio holdings. They could say it clearly and commit to allowing runoff of maturities.
They could also say, "We have the capacity to sterilize the existing holdings and allow them to mature and run off in an orderly way." That assurance would convey that the overhang of the Fed's large balance sheet will not be disturbing market-based pricing forces. They could point out the tools they would use under these circumstances. Longer-term reserve deposit structures constitute a tool that has already been tested by the Fed. Why doesn't the Fed point that out with clarity?
They could say that tapering is a word dealing with changes in the rate at which they acquire assets. They could define it. They could give gradations of amounts. They could say, "We'll take $85 billion, and our next step will be to reduce that $85 billion to $70 billion. We'll wait two meetings to see how the markets have absorbed the change, and then we'll reduce it again to $50 billion. Or an amount that is appropriate." That is clarity.
Markets could then figure out the implications. If the federal deficit shrinks as it has been doing, and if the US central bank tapers proportionately, the combination of actions will keep the floating supply of US government securities stable worldwide. We can pencil out estimates of what will happen to interest rates on Treasury securities and therefore on other securities. The right balance is quite favorable to markets. More importantly, it reduces risk premia and therefore encourages growth in the real economy.
These are the kinds of statements that would give clarity and direction to markets. And offering clarity and direction to markets means an immediate shrinking of risk premia. Smaller risk premia in the government securities sector allow the private sector and private sector finance to flourish.
The last month has seen failure in communication by major policy makers. They have the ability to correct their course. They will not come out and admit their mistakes. Rarely do we see a central banker so forthright. They should, however, attempt to introduce more clarity. We expect that from Bernanke, Japanese leaders, the Bank of England, and the European Central Bank.
Will we get it? That remains to be seen.
Meanwhile, the bond market sell-off in spread products like tax-free municipal bonds is overdone. Munis are cheap. The stock market corrections are running their course. The policies of the world's major central banks remain focused on very low interest rates, balance sheet expansion, and very slow, but gradually accelerating recoveries. That mix allows for an upward bias of asset prices.
We remain nearly fully invested in the US and international stock markets. We think the Japanese stock market is going to head higher strategically, while the yen will weaken at the same time.
We look forward to the next salvos coming from our central banks. Meanwhile we are off to Leen’s Lodge for a visit next weekend. This is the first of three annual gatherings in the village of Grand Lake Stream, Maine. We are about 35 in attendance. Central banking and geopolitics will be among the topics discussed. I’m hopeful a friendly small mouth bass will be a frequent distraction.
The notion of the Fed and the BOJ took me to the lines of a song which may be performed by the Randy Spencer Trio at Leen’s during the weekend. Some of the older folks in our readership may remember this from Bob Dylan or from The Band.
“I see my light come shining
From the west unto the east.
Any day now, any day now,
I shall be released.”
BY David R. Kotok