The Fed Has Investors Overjoyed, And it's For All the Wrong Reasons

I suspect that I will always remember where I was when the Federal Reserve stunned markets on Wednesday by deciding not taper its experimental support for markets and the economy — just like I suspect that I will always remember where I was on May 22nd when the Fed surprised many by indicating that a taper was likely to be forthcoming. In-between, markets have gone on a wild roller coaster roundtrip that also speaks to what continues to be a disappointingly tentative economic recovery and frustratingly weak job creation.

All this is quite perplexing given that the Fed is not in the business of surprising markets, and understandably so. Surprises tend to increase uncertainty premiums which then can act as a tax on financial intermediation and economic activity. They can also undermine the credibility of an institution that is central to the wellbeing of the nation.

If anything, the Fed under Ben Bernanke has made a point of enhancing “transparency.” Mr. Bernanke is the most communicative chairman in Fed history. He and his colleagues are releasing more data and projections than ever before. And Janet Yellen, the Fed’s vice governor and Mr. Bernanke’s likely successor, has led a comprehensive transparency initiative.

Yet the Fed has ended up surprising in major ways over the last few months, leading to wild gyrations in markets. The Dow collapsed by 5% between May 21st and June 24th, before surging by 8% to a new record close on Wednesday. Commodity and bond markets have also been quite volatile, with the benchmark 10-year Treasury unusually trading in an almost 50 basis point range.

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