What is the Fed Really Thinking?

Last week’s rally was ignited by a simple change of phrasing in the FOMC statement. Market took that to mean not only that increases are off the table, but — Hallelujah! —  a rate cut is in the offing.

Not so fast.

Whenever the Fed says or does something that is subsequently misinterpreted, they have a few back door methods to correct the error. Two in particular were used fairly regularly. Call it the Fed edit/correction methodology.

When John Berry was at the Washington Post, he could be discretely contacted. He’s now the Fed columnist at Bloomberg, and while I’m sure he maintains his FOMC contacts, we haven’t seen him "break news" like his WaPo days. He primarily does analysis, and he is very insightful as to what the the Fed is thinking. That’s quite valuable, but its not the same as "getting the call."

These days, that takes place with the WSJ’s Greg Ip. And in a page one article, he lays out what the news is from on high:

"When the Federal Reserve last week altered its
post-meeting policy statement to soften the suggestion that it might
raise interest rates, Wall Street was confused.

Was the Fed signaling that a rate increase was less
likely because the outlook for the economy had darkened? Or was it
simply reflecting the reality that interest rates are on hold for now?

The answer to both questions is, yes."

With no one quoted, and no speech is cited, one has to assume this is straight from the horse’s mouth. The WSJ doesn’t print factual statements about the Fed on the front page without knowing this is precisely what they are thinking. That’s simply not how they roll.

So we can assume that Mr. Ip. is repeating what he was told by very senior Fed Sources. Consider the specifics of the following:

"The Fed is seeing increased risks to its forecast that
the nation’s economy will grow moderately this year. Those risks
include the surprisingly weak level of business investment and the
hard-to-predict outcome of the current troubles at the riskier end of
the mortgage market.

The Fed changed its statement last week to get the
flexibility to cut interest rates in coming months if those risks grow.
But it is unlikely to use that flexibility anytime soon, because the
risks aren’t big enough and inflation remains uncomfortably high
. (emphasis added)

I’ll bet you that the last underlined sentence came verbatim from the Fed. If it was not emailed, than it was spoken slowly and repeated. And the surprisingly weak CapEx chart? Yeah, you can assume that has the Fed nervous.

Here’s another classic insider line (and the word   "Housekeeping" is classic bureaucracy speak):

played a part, as well. For several months, some officials saw the
Fed’s previous policy statement, which had indicated rates could rise
but not fall, as increasingly inconsistent with their own expectations
of unchanged rates for the foreseeable future.

We are only to the middle of the article, and we get the conclusion:

The new statement reflects a Fed on hold. It contains
no explicit reference to the direction of rates, saying only that
"future policy adjustments will depend" on growth and inflation, but
reiterates enough inflation concern to indicate lower rates aren’t on
the table.

The rest of the piece is worth a read, but after this point its just a standard article. All of the prior paragraphs can be considered dictation from the Sermon on the Mount.


In our adjusted for reality FOMC statement, we noted
the Fed is dealing with two difficulties: stubbornly high inflation and
a slowing economy. And, we noted the crowd has likely got the subtlety of the FOMC statement wrong. That turned out to be surprisingly prescient.

Greg Ip’s column is the first phase of the FOMC editing. Expect a few Fed Governor speeches over the next few weeks to further edit and clarify what they really meant . . .


Fed Has Trouble Getting Across Nuanced Message
Outlook for Economy Looks Bleaker, but Rates Aren’t Likely to Change
WSJ, March 27, 2007; Page A1

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What's been said:

Discussions found on the web:
  1. ac commented on Mar 27

    The way the Bretton Woods II countries are liquidating the International system, they want the FED to continue raising short rates. No surprise.

  2. Winston Munn commented on Mar 27

    Somewhat interesting that the Fed would go to this length to explain themselves, which in essence seems an attempt to slow the rise of the equities markets – perhaps they are seeing “a little froth at the top” and are trying to limit the damage.

  3. dave commented on Mar 27

    The amazing thing is that the market looked at the ‘balanced’ risk or neutral bias as the end of the discussion. While the fed may have came to that conclusion, it would seem that they clearly elevated both those risks. They are not neutral because the world is in perfect harmony, they are neutral because they are worried about both inflation and a recession. And the two are not exclusive. I think their fear is stagflation, which I am not sure if there is a monetary solution for other than to kill the inflation and let the economy adjust to the recession on it own. As the dollar approaches its multi-decades low, it would seem the currency market feels that the Fed is willing to sacrifice the dollar to prevent recession. Certainly not the goldilocks fed statement the stock market took it to be.

  4. pjfny commented on Mar 27

    The fear of a dollar crisis is the main reason the fed would be very reluctant to lower rates. A dollar crisis would be the worst of all worlds, because it would mean higher mkt rates (longer end) exactly when the us economy does not need it. This fear is very underappreciated (IMHO) by the pundits/economist and the mkt.

  5. V L commented on Mar 27

    The Fed is freaking out about the economy much more than they tell us. I do not know how else to explain them working overtime to print more money – M2 spiked by 24.5 billion last week.

    Hmm… Where did all this extra liquidity go? Stock market? Oil? Definitely somewhere, but it did not flow into the subprime market for sure.

  6. OldVet commented on Mar 27

    Glad I kept those EM short positions, even tho I’m underwater and covered the rest. Lots of gamesmanship going on. I think the extra M2 money went to big banks to buy up crappy loan portfolios off the mortgage hucksters who are failing, to be flogged off quietly at steep discounts to work-out firms. I wonder if the Fed ever gets its money back, or cares. Has the quiet bailout already begun?

  7. Shrek commented on Mar 27

    I hope the fed has realized the as soon as the y stopped raising rates in May financial conditions loosened considerably and probably led to the final housing blow off top.

  8. wally commented on Mar 27

    It is still hard for me to see, given the bubble history of our current era, that the Fed could lower rates. It has been clearly shown that they have no control over what the easier credit and increased liquidity are applied to… and the current crop of monied institutions has no sense of responsibility whatsoever.
    It is like giving whiskey to a kid.

  9. brewster commented on Mar 27

    Hussman yesterday

    “Given continuing inflation pressures and an otherwise unambiguous tightening bias, whatever room the Fed left open for policy change was clearly to allow flexibility in the event that the housing market deteriorates profoundly. A Fed cut is likely to be put into practice only under conditions that nobody would wish on this economy.”

    “Conditions nobody would wish” describes the rate cut scenario pretty well.

  10. dave commented on Mar 27

    if the fed thought the market misread their statement, why would they drop in an eight-day repo yesterday?

  11. Sponge Todd Square Pants commented on Mar 27

    ” In our adjusted for reality FOMC statement, we noted the Fed is dealing with two difficulties: stubbornly high inflation and a slowing economy. ”

    hmmmmm…smells like stagflation to me Barry.

  12. Mike_in_FL commented on Mar 27

    I think the stagflation case has a lot of legs here. We keep hearing about how inflation is a lagging indicator, how it will come down, blah, blah, blah. But here we are nine months after the Fed stopped hiking and inflation is STILL not coming down. The year-over-year change in core CPI was 2.6% when the Fed stopped hiking in June 2006, and it’s 2.7% now. There is NO evidence whatsoever that measured, core inflation is falling. On top of that, MARKET-based, real-time indicators of inflation are starting to rise fast. 10-year TIPS spread is blowing out to the widest since September and the yield curve is dis-inverting amid long-end inflation fears. If the Fed comes out and signals that it will try to “save” housing by cutting rates, it might achieve the exact opposite effect. How? By causing long bonds to sell off and the yield curve to steepen. That would help drive UP rates on the very same longer-term, fixed rate loans (30-years) that are supposed to save consumers from unaffordable ARMs.

  13. V L commented on Mar 27

    It is so true and funny!

    “The difficulty is that the Fed can’t act on these concerns because the economic situation has started to decay as well. As I noted last week, the economy has its head in the freezer and its feet in the oven, and Wall Street wants to call the temperature “just right.”


  14. RMX commented on Mar 27

    Mike_in FL,
    For the longest time, no matter in which direction the long-end yields were moving, the spread between the 10 and 30 seemed to be stuck at only around 8-10 bp. More recently, it has quickly moved out to around 20bp. Will be interesting to see if this trend continues.

  15. Mr. Bubbles commented on Mar 27

    Greenspan’s “conundrum” will cut both ways. Long-term yields remained suppressed in the face of a rising Fed Funds rate, and will rise significantly when the Fed gets around to cutting. This will hit the refi market even harder, exacerbating the housing downturn. The Fed is stuck, and they know it.

  16. VennData commented on Mar 27

    Where’s Maria Bartiromo to clear this all up when you need her?! Ben lose her number?

    ‘Cuz if Ben stopped going to parties where he might ‘run into’ Maria – you know, parties, where they have punch bowls – that would be good news for he dollar, but bad news for the pension fund, endowments and foreign central banks that are sitting on all those sub-prime-based CDO’s.

    Oh and bad news for Joe Six Pack, Larry Lawnmower, and Sally-Single-Mom and their recently bought digs.

  17. RP commented on Mar 27

    Banks borrow short term from the Fed and lend long term into
    the mortgage market. They will be able to lend at any rate,
    profitably, if the Fed desires. The Treasury would be the one
    impacted by higher long term rates, but I suspect the Fed can
    buy there too without problem…at least until other players decide
    that the money is nearly funny….monetary confidence seems to
    be the only real boundry here.

  18. Eclectic commented on Mar 27

    Hey Barringo,

    I’ll thank you to cool it with the iconoclastic allusions of yours… You’re steppin’ on my territory!

    If anybody’s gonna be scripturilizin’ on this bloggin’ site about various versions of the newfangled testament, IT’LL BE ECLECTIC that’s doin’ it… you hear!

    ‘Sides, I recken your tribe don’t match, come back?

    All in fun, Barrringo, all in fun!

  19. theroxylandr commented on Mar 27

    Barry, you are %$#^ genius! Amazing post…

  20. Eclectic commented on Mar 28

    I’ve often wondered if it’s true that Greg Ip is a conduit for the Fed.

    I hope it’s not true, although I have nothing against Ip. I’m quite sure were I a financial journalist I’d probably enjoy such a privilege if I had it. However, I just don’t think it’s good policy for the Fed to select any particular journalist as a sort of “Deep Throat” in reverse.

    However, in this particular case I’m not so sure Ip has given us anything that we didn’t already know… For example, Minter and Weiner over at Comstock pretty much nailed the statement in their last Thursday commentary, “A Monty Python Moment,” 3-22-07, found here:


    Here’s their opening sentence in that piece: “The Fed policy statement is both intriguing and irrelevant.”

    The piece only gets better after that, as they fully justify their opening remark. The WSJ couldn’t have run a better piece than if they’d just gotten permission from M/W and lifted the whole thing to their front page.

    If the Fed is using Ip as a conduit, it’s only because he’s the best direct pathway into the heart of the philosophy that runs the WSJ, and that philosophy is to spin anything the Fed says in favor of buying stocks.

    Good news is good news. Bad news is good news. No news is good news.

    In a sense then, directing communications to Ip is much like when a teacher needs to be away from the classroom for some reason for a short while, and the teacher must leave a favorite student behind that is in charge to take names of misbehaving students. The teacher knows they have to do this, because he or she also knows the students will always misbehave… it’s hotwired in their chromosomes and dyed-in-the-wool of their DNA.

    Did we need the WSJ to know the Fed is ass-deep in problems with no good solutions to any of them?

    Did we need the WSJ to know the Fed must eventually yield to its Monetarist heritage?… No, and even I, lowly Ecectic, have told you in explicit detail on this blog why monetarism can and often does fail.

    Take a look at where the 10-y-T was when I wrote comments to this Big Pic topic:



    It was another time when the financial world was all full of the notion of fearing the Fed will take rates higher.

    The Fed has its foot nailed to the floor and it’s going around and around in circles, because that’s all it can do.

    -It can’t generate jobs.

    -It can’t prevent the housing blow-off.

    -It can’t prevent the competitive build-out of off-shored business enterprise.

    -It can’t prevent Wall Street from subverting its monetary policy decisions.

    -It can’t do anything but puff up like a blowfish and display its Monetarist heritage.

    It’s like an alcoholic that’s trying to stay off the booze and using Ip to chastise the partygoers for serving up the cocktails.

    I’ve made the point before: The Fed is unable structurally to serve both the masters it needs to serve. One is the integrity and stability of the monetary system, and the other is the convenient politics of the time. They must always defer to the politics, and thus they typically fail at what must by all reason and logic be their primary responsibility… the integrity and stability of the monetary system.

    Finally, in this recent environment of a housing situation that is, by the day, revealing insights into excesses in that industry that even surprise me, if anyone thinks the Fed is predisposed to raising rates, you have plateaued into a dimension of space and time typically only found in episodes of “The Twilight Zone.”

    Barringo, you quoted Ip and added emphasis:

    “The Fed changed its statement last week to get the flexibility to cut interest rates in coming months if those risks grow. [But it is unlikely to use that flexibility anytime soon, because the risks aren’t big enough and inflation remains uncomfortably high.]” [your emphasis added]

    I gotcho emphasis right here. This Fed would cave and cut rates so fast you’d miss it if you go pee, and my guess is that they’ve already talked it up as to when and how much if this shebang shows any worsening signs of unraveling at the seams.

  21. brion commented on Mar 28

    prolly so Eclectic… Inflation is usually the politically expedient “path of least resistance”…..but W’s reign is unraveling simultaneously….

    is it -different this time-?

  22. Eclectic commented on Mar 28


    I don’t mean politics in the sense of party, but rather politics in the sense of the governmental organization of peer pressure that influences the Fed, whether it comes from the Right, the Left or the Center.

    Is it different this time you ask?

    Well, I will observe that the last time the Fed was this flummoxed was in the mid-years of the Carter Administration when the Fed was generally under the influence of Keynesianism, rather than the merely identity-challenged quasi-Keynesianism of this combination of government fiscal policy with a Fed which is at its heart still attempting to hold to Monetarist doctrine.

    Carter’s administration was attempting to pump the money supply to stimulate growth in the face of failing U.S. domestic steel, automobile, paper and other industrial production, because American industry had become complacent and the money supply was being yanked out from under us by the energy crisis then.

    Today, the Monetarist Fed pumped the money supply partly because of energy, but mostly because a failing domestic GDP had run out of growth engines, save the housing industry which the Fed has now almost pushed over the brink.

    So, I hope you understand that the politics I mentioned are not party specific. The problem is that the Fed is charged with a dual responsibility that he can not meet, without itself causing economic imbalances.

  23. brion commented on Mar 28

    i dig. I meant that inflation is usually the most expedient path politically in the Universal sense. It’s just that W is now the lamest of lame dux. (implication is that the Fed is “free-er” to chart the best possible course for the economy-whatever the F that is)

    “We’re in a tight spot”
    -Oh Brother Where Art Thou?

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