Why Traders And Economists Don't Get Each Other On Monetary Policy

ben bernanke

Economists and traders have inherently different market philosphies — the former believing prices are essentially right and the latter that mispricings are rampant enough that the smart guy stands to profit.

So it’s no surprise, writes Greg Ip at The Economist, that the two are talking past each other about the recent bond market sell off.

From The Economist:

These different world views help explain why traders have always been suspicious of quantitative easing (QE) and economists dismissive of those suspicions. Stan Druckenmiller, for years a remarkably successful hedge fund manager, in May accused the Fed of “running the most inappropriate monetary policy in history.” The Treasury bond yield, he argued, was the most important price in the economy and QE was contaminating that price, allowing countless other assets to deviate dangerously from sensible levels. Economists Brad DeLong and Paul Krugman chalked traders’ criticism up to sour grapes: they had tried to profit from the mispricing QE caused, and lost.

Back in May, when the Fed attempted to ready markets for a QE taper, officials likely assumed that because they were not signaling when short-term rates would go up, bond yields wouldn’t go crazy, Ip writes.

We know how that went.

Baffled, the Fed saw this as a communications breakdown. So Chairman Bernanke struck a more dovish tone in his Q&A session this week, effectively saying, “Please chill out; rates will remain low for the forseeable future.”  

“Perhaps no one thought so large a selloff was necessary,” Ip writes. “But each player sought to move before everyone else did. This dynamic is not easily modelled by economists, but it matters.”

Fed officials should be mindful that the market means something different for a trader than it does an economist.

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