Fade the Fed on Housing

A common aphorism for traders is “never fade the Fed.” Great import used to be placed in the money supply, and the Fed’s FOMC statements were scrutinized for nuance to give a hint as to future direction. As inflation faded, so did that scrutiny. Today great import is placed on the Fed Funds rate, and FOMC statements are analyzed for any change of language. Nothing much changed today, and the market went up.

I sometimes wonder if our society has gone Medieval, arguing over how many angels could fit on the head of a pin; or today, how many angles can fit within the spin of the Fed.

The Fed initially was formed to handle bank panics, specifically the Panic of 1907. It had a regional structure, much like what existed before the Fed was formally made the central bank in 1913, and the regional banks issued notes with varying rates depending on the health of that part of the country. They stood ready to back a failing bank and prevent a run, and then failed their first major test in 1931.

The Fed was expanded in the 1930s to manage Treasury issuances, and hence the money supply; and in the 1970s was expanded again to be required to push for a full-employment economy. This made no sense, as controlling money and pushing employment can be contradictory goals, as we all found out: the pressure to inflate to keep the economy going led to a debacle that tight money had to settle.

Today the Fed has been expanded again, and is now seen as the overseer of the whole economy. This adds even more contradictory goals to the Fed’s role. When an institution is pulled in conflicting ways, how can the “never fade the Fed” aphorism make sense?

To me this was clearly spelled out in recent FOMC statements about the economy. Today’s statement was that the economy was improving, but rates would be held low for an extended period. Isn’t this what got us into a bubble after 2002? Of course you can rationalize why it makes sense, especially if you worry over a repeat of 1937 again: the economy was on life-support, and was growing, but when the extraordinary measures were just slightly pulled back, the economy tanked. Is this then the fate of our overly-stimulated economy? If so, something is terribly wrong with how we are attempting to manage the economy.

We cannot answer such a question yet – history will tell. But we can ask whether the FOMC statements have been good or poor guidance, particularly on their latest role, managing the economy. If poor, this bodes really badly for following their extrapolations.

Maybe it would be better to fade them? Big money is made in investing when the herd is all on one side – the smart investor fades the herd.

CalculatedRisk’s assessment of the FOMC statement gives a great example of where fading the Fed makes sense, in this case on real estate. Just consider their FOMC statements, and read the tea leaves of their inability to predict the housing market:

Nov, 2009: Activity in the housing sector has increased over recent months
Dec, 2009: The housing sector has shown some signs of improvement over recent months
Jan, 2010: No comment
March, 2010: Housing starts have been flat at a depressed level
April, 2010: Housing starts have edged up but remain at a depressed level

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