One only has to look at the way the Australian dollar bounced today to see how the markets are now being driven by any and every utterance from the US Federal Reserve Board chairman, Ben Bernanke.
Indeed, you could look at the way just about every form of financial asset responded to his comments and the release of the June Federal Open Market Committee’s minutes to realise markets are now being driven by interpretations of every nuance in Bernanke’s and the FOMC’s statements.
Given that the commentary flowing from the Fed is confused and conflicting, it isn’t surprising that the attempts to interpret them are generating considerable volatility in markets.
Last month Bernanke triggered a massive sell-off of risk assets around the globe – and sent the Australian dollar plummeting – when he said the Fed might begin scaling back its $US85 billion a month of bond and mortgage purchases within months, with a view to ending the program around the middle of next year.
While the statement was qualified – it was subject to the Fed seeing a sustainable improvement in the US economy – it ignited a stampede for the exits from exposures to risk assets and an unwinding of the multitude of carry trades underpinned by access to cheap liquidity.
Overnight, however, Bernanke said the "overall message is accommodation" and that a "highly accommodative" policy was needed for the foreseeable future.
"There is some prospective, gradual and possible change in the mix of instruments but that shouldn’t be confused with the overall thrust of policy," he said. The current settings of high unemployment and low inflation meant the Fed had to maintain its stimulus.
The FOMC minutes, meanwhile, didn’t provide any clarity on the future path of the QEIII program other than to confirm that there is a divergence of view within the committee about whether and when to begin reducing the rate of bond and mortgage purchases.
A part of the explanation for the apparent confusion in the market, and the apparent shifting position of Bernanke, lies in the reality that the Fed’s policy is driven by the evolving state of the US economy.
It is clear that he remains concerned about 7.6 per cent unemployment rate and the negligible inflation levels – he wants a materially lower unemployment rate and a pick-up in inflation before any definitive change to the quantitative easing program let alone any change in the federal funds rate, which is near zero.
Significantly, last month’s comments resulted in a material spike in US bond yields, which probably helps explain why Bernanke said what he did last night. With US fiscal policy tightening the last thing he would want is to see market rates rise and choke off the modest recovery occurring within the US economy.
The confusion surrounding the Fed’s policy arises, perhaps, because he appears to be trying to achieve two potentially conflicting objectives with his public commentary.
Last night he clearly wanted to reassure markets and other participants in the economy that the Fed would maintain its stimulus until there were clear signs of recovery. Last month, it seems, he was trying to blow some of the froth off the bubbles of risk-taking the QEIII program has generated.
When asked about those statements last month Bernanke asked people to "consider the counterfactual" and suggested that markets could have been even more leveraged if they were under the impression of an "infinite QEIII" and therefore his comments may have helped avoid a larger problem later.
Monetary policy is a blunt policy tool. Trying to maintain an highly expansionary stance while simultaneously taking the heat out of markets is beyond it, so Bernanke has tried to use his commentary to "jaw bone" the markets into thinking that the likelihood of an imminent tapering of QEIII was far more certain than the actual Fed position.
The problem with that strategy can be seen in the markets’ responses to his latest comments that the Fed’s accommodative policies could remain in place for the rest of this year and in to the next.
There was a rebound in bond prices, equity and commodity markets surged and there appears to have been a flood of money back into emerging markets, the Australian dollar and the risk positions that were being abandoned only last month.
So, last month the markets, in Bernanke’s view, over-reacted to his attempt to take a little heat out of them and prevent incipient financial bubbles swelling further. Last night, in trying to prevent that response from damaging the real US economy, he reversed the flood of funds and encouraged it back into the risk assets he was trying to discourage a month ago.
No wonder the markets are confused and volatile.