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We Are All Epsilon Theorists Now

Summary:
Jay Powell describing the current size of his credibility at Friday’s press conference I’ll save my specific investment advice on Jay Powell’s narrative about-face last Friday for ET Pro subscribers, but I’ll share the title of that note: “LOL“. I mean, if you can’t laugh at this sort of craven performance art, you’re taking the world way too seriously. All of that stuff from December’s FOMC meeting about looking at the real economy to figure out what monetary policy should be? All of that stuff about caring more about Main Street than Wall Street? JK! At Friday’s presser, Jay Powell did what I thought he would do in December – he answered the prayers of all the Wall Street penitents, from schlocky TV evangelists like Jim Cramer to hair-shirted saints like

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We Are All Epsilon Theorists Now
Jay Powell describing the current size of his credibility at Friday’s press conference

I’ll save my specific investment advice on Jay Powell’s narrative about-face last Friday for ET Pro subscribers, but I’ll share the title of that note: “LOL“. I mean, if you can’t laugh at this sort of craven performance art, you’re taking the world way too seriously.

All of that stuff from December’s FOMC meeting about looking at the real economy to figure out what monetary policy should be? All of that stuff about caring more about Main Street than Wall Street?

JK!

At Friday’s presser, Jay Powell did what I thought he would do in December – he answered the prayers of all the Wall Street penitents, from schlocky TV evangelists like Jim Cramer to hair-shirted saints like Stanley Druckenmiller. Please Lord, make me chaste … but not yet.

Powell on Friday: I hear you, my children. I hear you.

And there was much rejoicing.

Back in 1971, when Nixon took the U.S. off the gold standard and adopted a broad swath of activist and “modern” monetary policies, he famously said (ruefully, if the stories are to be believed), “I am now a Keynesian in economics”. In this he was channeling Milton Friedman, who coined the phrase “we are all Keynesians now” in the 1960s to describe the overwhelming political pressure to adopt easy money and stimulative policies whenever cold economic winds start to blow.

Today, though, easy money and stimulative policies aren’t enough. Or rather, they are so commonplace, so expected and banal, so much the warp and woof of Western political order, that it’s not enough – not nearly enough! – to have an incredibly accommodative and market-friendly policy of ultra-low interest rates and a massive balance sheet.

No, today just DOING the right policy isn’t enough. You’ve also got to SAY the right policy.

In fact, saying the right policy IS the policy.

And everyone knows that everyone knows this is true. It’s the most pervasive Common Knowledge of our modern economic lives, that the instrumental words of “guidance” are themselves the only policy of meaning.

We are all Epsilon Theorists now.

The seriously messed-up LOL part of this is that the most confirmed Epsilon Theorists today are the central bankers themselves, along with their staffers. How do I know?

Because they’ve started to create econometric models of the impact of their own empty words.

Case in point: BIS Working Paper 761 “Non-Monetary News in Central Bank Communication” by Anna Cieslak and Andreas Schrimpf, published last month. (h/t long-time ET reader and pack member Clive Hale).

The paper is written in the modern day cant of academic economics, with trenchant prose like this:

We Are All Epsilon Theorists Now

So the money quote will need a bit of translation.

“we show that the non-monetary information content—i.e., news about economic activity and shocks to risk premia—dominates more than half of communication events. … Risk premium shocks exert substantial nonlinear effects on asset prices, and their importance increases with the implementation of unconventional monetary policies.”

In English? Since the Great Recession, central banks – especially the Fed and the ECB – talk less and less about their actual monetary policy decisions. But they talk more and more about their expectations of investment risk and reward in capital markets. Their instrumentally constructed opinions about investment risk and reward – which are presented as “news” – move markets dramatically. And dependably. And predictably.

It’s not your imagination. The words of monetary policy authorities about everything BUT monetary policy have enormous power. More power than the monetary policies themselves. They know it. You know that they know it. They know that you know that they know it.

We’re a very knowledgeable family.

LOL.

The machines didn’t do this. The quants didn’t do this. We did this. We willingly gave ourselves to the Powells and the Draghis and the Bernankes and the Yellens. We willingly gave ourselves to the Cramers and the Hilsenraths and the Buffetts. We willingly gave ourselves to the Obamas and the Trumps. We willingly sold our soul to the Narrative devil.

And we’re not getting it back.

This is why your fundamental research doesn’t matter anymore.

This is why your fundamental research will never matter again.

We are all Epsilon Theorists now.

About Ben Hunt
Ben Hunt
He is the chief investment strategist at Salient, a $14 billion asset manager based in Houston and San Francisco, and the author of Epsilon Theory, a newsletter and website that examines markets through the lenses of game theory and history. Over 100,000 professional investors and allocators read Epsilon Theory for its fresh perspective into market dynamics.

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