Has market lost faith in Bernanke?
The Fed's so-far-mild policy shift doesn't seem to justify the depth of this plunge. But traders seem to have lost confidence in the Fed chief -- and are worrying about who comes next.
By John Carney for CNBC.com
Ben Bernanke has clearly "roiled" markets.
That's apparently the official word for the reaction to Bernanke and the FOMC's statements Wednesday -- roiled. It was everywhere Thursday as the market plunged.
But are the markets over-roiled? Bernanke on Wednesday explained the Fed's projected path to ending quantitative easing depends on the strength of the economy.
If the economy performs as strongly as the Fed expects, organic economic growth will be allowed to replace policy-driven growth. If the economy underperforms, policies intended to stimulate growth will be kept in place for longer.
That should not be a reason for a massive selloff of financial assets. So what's going on?
Crisis of confidence
The stock market selloff may be a vote of no confidence in Bernanke and whoever follows him into the Fed chair next year.
If you think the Fed will taper faster than the economy grows, then a dip in equities is justified. A mistaken confidence in the strength of the economy by policymakers can easily become a drag -- especially if you think policymakers are likely to stick to their rosy views in the face of contrary evidence.
So what about bonds? They've also taken a massive hit. Here the picture is even less clear. In one sense, this is what you would expect. Bond yields take their cues from the expected path of future policy rates. The announcement that the Fed expects the end of QE next summer at least puts higher rates as a realistic possibility for, perhaps, 2015.
On the other hand, those who think the Fed is wrong about the strength of the economy should believe that rates will stay lower for longer. That is, they should be buying bonds on the dips. Unless, like those selling stocks, they believe the Fed will tighten too early—raising rates or paring back QE in the face of an economy that is actually still weak. Again, it's a vote of no confidence in the Fed.
No more cranking away
Finally, there's the question of what I'll call the Krugman Crank. Paul Krugman has forcibly argues in the New York Times for the view that the Fed's best -- perhaps only -- tool when interest rates are the zero bound is shaping expectations.
If the Fed can convince markets that it will keep turning the money crank even after the economy recovers, to the point of allowing inflation to rise beyond the usual target, it can encourage demand growth, Krugman contends.
The key to this, however, is that the Fed must credibly promise to be irresponsible. If the market does not believe the Fed will be irresponsible when it comes to inflation, the expectations channel breaks down.
What we may be seeing Thursday is the perception that the Krugman Crank is broken -- that the market no longer believes the Fed can credibly promise to be irresponsible. Which means that Fed policy becomes ineffective at the zero bound. So that even if the Fed did react appropriately to a slumping economy by refusing to taper as planned, it might not make a difference.
I'm sorry that so much of this depends on the central bank trying to control -- or losing control -- of what markets expect. Even worse, it depends on whether markets expect that the Fed can control what the market expects. The image of mirrors staring into mirrors comes to mind. But that is simply the world we live in.
Of course, it's still early days. We don't know how deep the selloff will go, or how long it will run. Perhaps the post-FOMC market moves will just be a blip. Sometimes a roil is just a roil.
— By CNBC's John Carney. Follow him on Twitter @Carney.
Also on CNBC.com:
VIDEO ON MSN MONEY
Looks like social security will continue to be a primary source of retirement income for the lost middle class. We sure the hell can not depend on our 401k money as the stock market is manipulated for income growth for only a few. retirement plans are gone and the health care system has been for many years a mess and needs a total over-haul. I and many others have lost faith in the USA retirement, educational and health care system. I thought as a Vet I would never lose faith in our countries abilities to solve our problems but I have, we no longer lead the way in the world. This country is motivated by greed .
No more hand holding, Wall Street.
Time to stand on your own 2 feet.
Wow! That is absolutely poetic!
After all these years, I think I found my calling!
Wall St. traders are like spoiled kids that throw a tantrum when they dont get their way. Its about time Main St. gets a break from dollar devaluation and out of control speculation driving energy
and commodity prices higher with out regard to supply and demand. Krugman should get 2 days
in the electric chair and if he survives give him a real job for minimum wage.
"Sometimes a roil is just a roil."
Yeah, and sometimes a BOIL is just a BOIL.
Does this article sound like a drug seeker seeking drugs, or what?
Sorry Middle Class,
It's motivated by STUPIDITY
Stupidity on most of the voters, who still think they have a choice, and stupidity of the 1% who think that they will NEVER be in danger.
Got news for you 1%.. Look up the French Revolution!!!
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