Will Bernanke Decouple From Greenspan?

With more than a year under his belt and his first crisis underway (sub prime), Ben Bernanke has arrived at that moment whereby he can separate from the Maestro and establish his central banker vision. Or he can follow the path of his predecessor, bail out yet another bubble-induced economic sector (housing), continue to flood the world with even more liquidity, and send a signal to the world markets and economies that his Fed supports Greenspan’s bubblenomics. My bet is that we will witness the beginnings of a clear break from such a policy. In this regard, Bernanke does have a precedent – Japan.

When the Bank of Japan recently raised rates, it sent a signal (albeit a modest one) that global liquidity via the carry trade took priority over domestic needs. Bernanke needs to send his own signal that his philosophy is truly his own, that it is different than Greenspan’s, and that the markets cannot rely on the Bernanke-put to rescue reckless economic decision-making. There is, however, a big risk that comes with being his own man. He may precipitate unintended (and unforeseen) consequences by exercising what Harry Paulson calls the “market discipline”.

Investment Strategy Implications

With the S&P 500 parked at the top end of the correction range (1410), the market has erased nearly all of its oversold condition and now stands poised at a key price point.

The FOMC decision today should set in motion the next steps for the market – either breakout of the range (and possibly make a run at a new all-time high) or trade down through it (and probably set a new correction low).

If the Fed makes the right call by not lowering rates, and, most importantly, does not change its language to neutral, the market may be disappointed and head south. While painful in the near term that, in my opinion, would be the right decision. And it would send a clear signal that Bernanke has begun to decouple from Greenspan and bubblenomics.

If, on the other hand (had to slip in an economist phrase), the FOMC does lower rates and/or change the language to something less hawkish, the markets may celebrate and conclude that the liquidity punch bowl is not going anywhere anytime soon.

Either way, today’s decision matters more than most.