On the Fallibility of the Fed

The Federal Reserve is not currently forecasting a recession.

Ben Bernanke, 2008

As an investing community, we love to hang on every word, if not every syllable, that is uttered by a Federal Reserve governor.

And while the Fed serves a vital role as an independent agency charged with the dual mandate of maximum employment and stable prices, and has overall served that role pretty well, we also love to complain about how they often tend to be too early, too late, or just plain wrong.

Former Fed chair Ben Bernanke’s quote from 2008, just before the Great Financial Crisis, is just one of many fantastic examples of where the future of economic growth is not as clear of a picture as we’d all like it to be.

Technical analysts used to get way worse treatment in the popular media, with top technical analysts being referred to as “reading the tea leaves” or called “snake oil salesman” as our tools and techniques were derided for being closer to astrology than fundamental analysis.

So perhaps I always felt that economists were kindred spirits in a way, trying desperately to analyze trends and anticipate future movements in the economy, and regularly and ruthlessly criticized for attempting to do so.

I’ve loved digging into books like Naked Economics: Undressing the Dismal Science by Charles Wheelan, where he explained in such entertaining ways how economists analyze economic conditions, while also acknowledging the challenges of trying to do so.

So while all eyes and ears will be on the Fed this week, and as they most likely lower the Fed Funds Target Rate by 25 basis points, I’ll be reflecting on the incredible challenge with which they are presented.  Basically, they are asked to keep inflation in check, make sure everyone has a job, make changes where the impact will not be measured for months, and do all of the above while everyone hangs on and critiques every word you utter.

Fed Funds Target Rate vs. Two Year Treasury Yield. Source: StockCharts.com.

The good news about technical analysis is that it’s based not on what the Fed chair says on Wednesday, or where we think inflation will be in six months, or how interest rates could impact homebuilders or consumer behavior, but about price.  And price provides perhaps the most important picture of investor sentiment, that is, what all the investors out there are thinking about all those things.

When investors are optimistic about future economic growth, prices tend to go up.  When investors start getting concerned about a potential recession, prices tend to go down.  And by following the trends in those prices, we can better understand the changing sentiment of the markets.

Mindless investors spend tons of time dissecting transcripts and trying to anticipate what the Fed will do tomorrow.

Mindful investors take a deep breath, and look at the charts.

RR#6,
Dave

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Disclaimer: This blog is for educational purposes only and should not be construed as financial advice.  The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.  

The author does not have a position in mentioned securities at the time of publication.    Any opinions expressed herein are solely those of the author and do not in any way represent the views or opinions of any other person or entity.