Fed's Transparency Creates Its Own Problems

As we await the Fed’s decision on interest rates from their meeting which concludes today and, more importantly, the press conference that will follow that meeting, I find myself in an unusual position...hearkening back to the “good old days.” It is unusual because life in a dealing room teaches you to be concerned only about the present and future; looking back with longing to a time when it seemed that profits were easier to come by is a futile exercise.

Back in the 1980s, when I was starting my career in the forex market, central banks didn’t telegraph their decisions or actions. They hit the market hard, with rate changes and direct market intervention, often at the same time. There was no attempt to cajole the market, just an iron fisted bullying approach to getting what they wanted...or at least it seemed that way at the time.

The irony was that those short but intense periods of chaos were usually immensely profitable. For a trader, volatility equates to opportunity. It doesn’t matter in which direction a market is moving as long as it is moving.

That all changed with the creation of the Euro and, more importantly, the European Central Bank (ECB). Coordinating monetary policy between multiple countries with different cultures, concerns and economic priorities demanded consensus, and that resulted in debates about policy becoming increasingly public. If, therefore, you find this protracted debate and endless speculation about what the Fed will do and what they will say about it frustrating, you can blame the ECB.

Now, though, living life outside of a dealing room, I am more inclined to be thankful for central bank transparency than frustrated by it. For investors, rather than traders, it makes life a little easier and somewhat more predictable. That doesn’t mean, however, that it will be plain sailing today as any rate hike is indicated and Janet Yellen speaks to explain the decision. The new transparency creates its own problems.

The uncertainty around this decision is not so much about the decision itself. Various Fed FOMC members have made it clear that they want to embark on a path of “normalization” of rates as soon as the data suggests that the economy can bear it. What is likely to cause a reaction, though, is any talk of the expected trajectory of future rate hikes. As one unusually humorous Wall Street analyst on CNBC put it, “It’s all about that pace, ‘bout that pace...”

That wild card aside, though, the current trend of central banks giving strong hints about their intentions does create both an interesting situation for traders and a problem for the Fed in this case. From a trading perspective we have seen over the last couple of days a reaction in anticipation of the move that, logically speaking, makes little sense. Higher rates are generally considered bad for stocks; they discourage borrowing for investment and divert money to interest bearing securities and away from the stock market. This time, though, with rates at virtually zero and any hike likely to be minimal, the prospect of a move up is being seen as a vote of confidence in the U.S. economy, and has thus resulted in buying of equities.

What is interesting for traders is that that move has already happened, thus creating the likelihood of a buy the rumor, sell the fact scenario. Certainly if things pan out exactly as expected the knee jerk reaction will be positive, but with everybody seemingly long going in that is unlikely to last. If, by any remote chance the Fed were to decide to delay things even further the selloff that would follow that news would be spectacular.

The problem for the Fed is that to some extent the FOMC has backed itself into a corner. They almost have to announce a 25 basis point rate hike and make it clear that there are no definite plans for future rises. Anything else will do serious damage to their credibility and result in chaos in stocks and, more worryingly, in an already nervous credit market.

Those potential problems are real and should not be discounted lightly, but on balance central banks’ indicating in advance what they are likely to do is a good thing, and something for which investors should be thankful. It may mean less opportunity for traders, but it does make informed long term decisions a little easier.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

Read Martin's Bio