Comparing Fed-Markets love affair to Disney movies

An interesting piece by Mohd. El Arian.

He connects this whole Fed-financial markets love affair to Disney movies. In both, the relationship so far has been to make sure the end is happily ever after. However, a recent Disney movie Frozen did not go the beaten path. He says Fed should do the same thing as well:

After many decades of Disney movies, we have been conditioned to expect princesses to fall in love quickly with their charming princes and “live happily ever after.” And when there are challenges or obstacles (mostly in the more recent movies), these are quickly overcome (and with humor).

Similarly, for many years market participants have been richly rewarded for falling in love – quickly and decisively – with the new policy measures adopted by America’s Federal Reserve. Indeed, the romance has overwhelmingly followed the Disney script. Yes, there may have been some bumps along the way, but they have been overcome quickly. And the romance has resulted in both parties living happily: the Fed feels better positioned to pursue its dual mandate of high employment and stable inflation, while investors feel that they have the opportunity for sizeable financial rewards.

This relationship has been so comfortable that market participants have adopted the mantra “Never fight the Fed” – and for good reason. The Fed is the world’s most powerful central bank. It owns the printing press that produces the world’s main reserve currency. It enjoys a significant amount of political independence. And it has not been shy about using its considerable operational autonomy..

This relationship could change in coming years:

Initially, central bankers were keen to cultivate this romance as a means of meeting their broader policy objectives of growth, employment, stable inflation, and financial stability. More recently, however, some have become less comfortable, warning that the codependence is encouraging excessive risk-taking and, in some cases, bubbly valuations. Some worry that it may even undermine the Fed’s political independence. And, only two weeks ago, an outgoing Fed governor, Jeremy Stein, declared that the Fed is in the middle of a policy transition that renders its guidance to markets “more qualitative,” “less deterministic” and, therefore, less precise.

Like Princess Anna in Frozen, it will take time for markets to recognize that their relationship with the Fed is changing (and should change); and, similar to the movie, some sort of shock may be involved in socializing the new understanding. Having said that, the outcome will certainly not be as dramatic as in the movie – if only because, unlike Hans, the Fed is not out to take over the markets.

So the romance will survive, but it is unlikely to be as intense, and it is unlikely to be unconditional. The hope is that, by that time, a more vibrant real economy will perform the role that Kristoff played in the movie.

The best and most sustainable love story for markets is one based on a healthy and dynamic real economy that creates jobs and opportunities for many more people. Unfortunately, on that count, it is too soon to predict whether we will live happily ever after.

Well, it is kind of ironical to read such pieces from former PIMCO chief which made tons due to this love affair with Fed. And one of the times when it bet against (it expected yields to go up in 2010 or something) it lost a lot of money. Since then there have been quite a few pieces criticising Fed policy.

But then this story does not end with Fed alone. It stands for central banks worldwide. This blog has been arguing  on the needless focus and attention on everything a central bank does (and doesn’t) and ignoring other institutions. The end result has been for all to see. Financial sector continues to bloom and others remain in gloom. From ignominy the central bankers have risen to demi-god like status with all eyes and attention. The econs who criticise this also do the same by becoming central bankers themselves. So there is no end in this love affair really as the game continues.

Very convincingly all the people in financial markets who don our business presses have made us believe that they and central banking is all that matters.  You get what you sow and this is what markets have always wanted. Only if our experts had focused on other real things, may be we could have avoided the whole mess.

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