The Fed Talks Too Much

Another interesting week in the markets. We saw some records broken. It is worth asking the question, “Why did this happen early in the week, and why did it reverse as the week progressed?” I have a theory. I’ll leave it to you to see if it adds up. The early week highlights I thought were important:

(1) The dollar hit a new all time low versus the Japanese Yen. This prompted the BOJ to intervene. The first time in six years.

(2) The CHF fell below parity versus the dollar (for only a half-day).

(3) Gold went on a tear.

(4) The dollar got weaker across the board.

(5) The 10’s – 30’s Treasury spread widened while the 2’s – 10’s spread narrowed.

What prompted these moves? I think it was the threat of QE-2. The market was full of rumors that the Fed was going to initiate a $1 trillion POMO buy to re-grease the economic wheels. The talk was that this very significant step could come as early as next week. This rumor had legs. It was repeated by the TV talking heads and also by some ‘white spats’ boys from Wall Street. The following was the opening line to an article written by Morgan Stanley early on Tuesday the 14th.

Let's start with policy and economic uncertainty – the Fed may open the door to QE2 at the September 21 FOMC meeting.

You can bet that if MS was writing this on Tuesday they were telling their clients well before this was published. As that talk spread, market players made bets. The bets were against the dollar and in favor of anything that was not paper money (gold). The long end of the Treasury curve suffered while the near end benefited. The market conclusion: “We hate QE”.

But then came the most amazing thing. A reversal by Morgan Stanley on the timing of QE-2. I was floored by this retraction:

"we now believe the likelihood of additional easing being announced at the Sept FOMC meeting is quite low (perhaps 10% to 20%)."

This type of flip flop does not happen very often. One has to ask the question, “Why?” For MS to turn on a dime like this means to me that someone whispered in the ears of MS: “You have the story wrong, There is no chance that we will introduce a major QE program in September. November is the earliest that could happen.”

There is only one source that could convince MS that they had to reverse their published position. It had to be the Fed doing the talking, In my opinion the Fed must have been talking to more than just MS. I think the Fed must have talked to most of the Street. As the concerns of an imminent QE eased, so did the tensions in the market. Save for gold, all of the early week “I’m afraid of QE” trades were reversed.

You could argue that I am reading too much into the MS flip-flop. I did not come to the conclusion re MS right away. My initial thought was that it was just laughable. Not nefarious. But then there was an article by Neil Irwin at the Washington Post. This article first appeared on Wednesday the 15th. This means that it was written based on information received on Tuesday (the same day as the MS flip-flop). This article was clearly written with input from Fed officials. Consider some of the phrases used in the article:

Fed analysts are exploring whether new bond purchases can do much to lower interest rates.

Fed officials are also looking for unintended consequences of new measures.

Top Fed officials will be preparing formal forecasts for the economy over the coming years in advance of their meeting Nov. 2 and 3.

Fed officials are also weighing whether lower rates would spur business investment.

Economists at the central bank are undertaking a new round of analysis on the likely impact of such moves.

The WaPo does not say things like this unless they have in fact gotten some clarity from Fed officials on what is the thinking and what is the timing. The paper ran an important article with no attribution for the quotes from “Fed officials” and "Top Fed Officials" (Bernanke is the only Top Official). They describe what "Fed Economists" and "Fed Analysts" are currently doing. Irwin has no idea what the Fed economists and analysts are currently working on. And I assure you that those economists and analysts do not speak with the press unless they are specifically told who to talk to and what to say.

The critical conclusion that one gets from the WaPo article is that nothing will happen at next week's Fed meeting.

No action is likely at the policy meeting scheduled for Tuesday.

The use of the word “likely” is just press talk. The actual words from the Fed “Officials” to Irwin were probably:

“As of today it is 95% sure we are not doing anything on QE next week. Please get that message out. The market thinks we are rushing into things too fast. We want to use the WaPo to change this thinking. We don’t want the markets to get ahead of us on this. It has having negative consequences in the markets and we are taking flack from the Japanese and Swiss CBs”

If you believe in my interpretation of these facts then you have to draw some troubling (and dangerous) conclusions.

(I) The Fed is using the press to shape public perception on what and when it will do things.

(II) The Fed is providing guidance to major Wall Street firms so they too can spread the message that the Fed wants. In the process they give those same firms a significant trading edge.

(III) The Fed was made acutely aware of the market’s dissatisfaction of a new major round of QE. They responded with sub rosa “Official Guidance” to redirect the market. This is intervention. It uses words not cash. But the result (this time) is the same.


In my opinion the Fed has provided information to the press on numerous occasions this year. Articles from the WSJ, NYTs and the FT have all contained information that had to have come from Bernanke’s lips. But there was never a confirmation that he was the actual source. It was always “Senior Fed Officials”. Editors of these big papers do not run stories like this without first confirming that the quotes are solid. They were solid. They were whispers from Ben.

I am troubled by the Fed’s attempts to use the media like this. If the Fed has anything to say they should make it public. If they want to talk to the media they should do it for attribution. Hints and disinformation are no way to run an open monetary policy.

I am quite comfortable about my assertion that the Fed is using the media. I am not alone in that observation. I am less confident regarding my conclusion that MS got a call from someone and as a result they quickly published a clarifying comment that reversed their opinion publish only hours before. To me, that would be more than just disinformation. That would be inside information that was very trade-able. The markets backed and filled for the rest of the week. The talk of an imminent QE died as of Tuesday. Big money was made in the process.

Tyler Durden at Zero Hedge got me thinking on this. He wrote about the MS flip-flop on Tuesday. From the article:

False Alarm: Morgan Stanley Recants From Its Expectation Of A QE2 Event In One Week

Today's peculiar stock trading action was exclusively due to Morgan Stanley's previously highlighted expectation that the Fed would announce QE 2 in one week.

The Fed talk is moving the bond, stock currency and gold markets. I would say that it worked rather well this time. But it is a losing strategy. To me it shows a weak hand.

The market showed Bernanke and Co. that it does not like the prospect of QE-2. That does not mean it will not happen. It means that when it does happen in November (conveniently one day after key elections) the markets will react accordingly. We are not done with the weak dollar, strong gold, scared 30-year and generally “risk off” markets. Ben just hid them in the closet for a few more weeks.