Everyone's talking about the Fed

For many months now anyone and everyone has had an opinion on what the US Federal Reserve will do next and when.

We all talk about it but nobody knows exactly what to expect.

It's possibly the most interesting monetary policy in the world right now and that's a problem. Why?

If investors aren't sure what policymakers have planned for us, they can't make well-informed savings and investment decisions.

While the Fed has come a long way in making it's policy decisions more transparent, the heated debate over the past couple of years has highlighted a significant shortcoming in US monetary policy.

Bank of England Governor Mervyn King prides himself on making monetary policy boring (i.e. predictable). This is important if a central bank is going to gain any credibility among investors.

Fed chairman Alan Greenspan still has a long way to go, no matter how eloquent his cryptic remarks may seem.

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The possiblity of further US interest rate cuts virtually disappeared when the inflation rate stopped slowing in 2003.

There seems to be no doubt in people's minds that the Fed's overnight rate will double by the end of 2004. In fact, it is now become the obligation of the Fed to do just that.

If you take a second look at the chart above you'll notice that by historical standards, today's pickup in inflation is very modest to say the least. This is mostly due to (implicit) inflation targeting on the part of the US central bank over the past 10-15 years.

The key question to ask is this: how concerned is the Fed about inflation right now?

If the Fed knew the answer to this question they would have made their next move on interest rates a long time ago.

If the Fed made it's inflation target more explicit, investors would have anticipated this move a long time ago too!

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Since the start of 2003 what we've had is a prolonged situation where both investors and the Fed alike have never been sure when the next move in interest rates would come. Until the Fed makes its policy target clear for all to see, people will not stop talking about it. This only adds to the uncertainty investors face every day. It's the job of policymakers to eliminate uncertainties, not create them.