Busch: Translating Fed Speak

Over the last 24 hours, we've had three Federal Reserve members speak out about the direction of the economy, the financial markets, and the future of monetary policy in the United States. With all the Hopium and Green Shoots chatter, the Fed members didn't have the consistent positive message that one would've expected.

Speaking at Tsingua University in Beijing, Dallas Fed President Richard Fisher(non-voting FOMC member) said the United States is in a "bone-crushing recession"and an "implosion"in export demand has been especially damaging to the United States. "This will be the first time since the 1940s that we have witnessed such a deep and synchronized retrenchment of global economic activity, and this makes tougher the task of growing the U.S. economy."Addressing the concerns that the Fed will be creating inflation with their massive monetary stimulus, he said that the world is groaning with excess capacity and that rising inflation should not be an issue for the next couple of years. " Presently, the risk is deflationary job destruction."

The most provocative comment had to do with the spending coming out of DC. He said "time will tell"if policies to restore growth and lay the groundwork for permanent structural reform - but which in the short-run will drive up the federal budget deficit - will succeed as hoped according to Reuters. "If these policies don't jump-start the economy, then I am confident that the reaction within fixed-income markets will force those with the power to tax and spend, the Congress, to readjust their fiscal policies."Fisher is explicitly telling the bond market to raise yields if they feel that Congress is spending too much. In other words, do the work of the Fed for the market because they either can't or won't.

Next up, President of the San Francisco Federal Reserve Janet Yellen (voting FOMC member) said that the tentative signs of improvement in recent economic data do not mean the U.S. economy is out of the woods. "While we've seen some tentative signs of improvement in the economic data very recently, it's still impossible to know how deep the contraction will ultimately be."The "adverse feedback loop" between financial markets and the overall economy continues to roll on despite the US entering it's sixth straight quarter of recession with economic activity and employment are still contracting sharply.

Yellen's most provocative comment had to do with the future of Fed policy. She wants it to be more aggressive and more interventionist. "It's evident that episodes of exuberance, like the ones that led to our bond and house price bubbles, can be time bombs that cause catastrophic damage to the economy when they explode.....I can now imagine circumstances that would justify leaning against a bubble with tighter monetary policy."Curiously, she mentions that the Fed's own policies between 2001-2004 were a cause of the current credit crisis, but it was a "calculated risk"against deflation. Hmm, what did Fisher say?

Lastly, Federal Reserve Bank of Atlanta President Dennis Lockhart(a voting FOMC member) spoke at the Levy Economics Institute and gave the cautiously upbeat scenario. Lockhart said, "Today, the economy is still very weak, but there are some encouraging signs that support cautious optimism...My outlook calls for the beginning of a recovery in the second half of 2009. I do not expect a strong recovery, but I do expect the economic contraction we're now experiencing to give way to slow and tentative growth as early as the third quarter."

While Lockhart's comments were not outré, he did have this bon mot: "The financial crisis in this country has resulted in financial industry consolidation. The effect of industry consolidation is greater concentration without, as yet, much reduction of systemic risk."Translation: the financial industry is now more top heavy with larger, too-big-to-fail firms and no change to the risk. Even with a good quarter, one has to wonder what adventures lie down the road for US financial firms with this structure in place.

The point to keep in mind with Fed speak is whether there is a consistent theme to the comments. If yes, this means that the voting and non-voting members have a shared view on the outlook. With these three speeches, the mutual view is caution.

This means the foot stays squarely on the gas and the balance sheet.


Andrew Busch
Andrew Busch

Andrew B. Busch is Global FX Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a frequent CNBC contributor. You can comment on his piece andreach him here and you can follow him on Twitter athttp://twitter.com/abusch .