The reviews are in for Federal Reserve Chairman Ben Bernanke's matinee performance Monday, and they are not particularly flattering.
If Bernanke's goal was to let financial markets know the central bank intends to raise interest rates again June 29, "he should probably have avoided using tear gas canisters to send the smoke signals," Action Economics chief economist Michael Englund said in a research note published Tuesday.
Jittery investors, still getting used to the blunt-speaking new Fed chief, reacted to Bernanke's tough talk on inflation in a Monday address to an international bankers conference by dumping stocks. The Dow Jones industrial average, which just last month came within shouting distance of its record high, has shed more than 2.5 percent over two days and closed Tuesday at its lowest level in nearly three months. In one encouraging sign, however, the market recovered late in the session and closed just above the 11,000 level.
"The seeds of confusion continue to be sown by this new Fed, and there is no doubt a risk we will see a policy misstep at the end of June," Merrill Lynch chief economist David Rosenberg said in a research note.
It is not the first time Bernanke has sent financial markets into a tizzy in the four months since taking over from his legendary predecessor Alan Greenspan, whose sometimes-opaque utterances were nonetheless well-understood by financial markets.
Bernanke, still laboring under Greenspan's long shadow, also is handicapped by the lingering perception among bond investors that he is "dovish," or soft on inflation. That view is based largely on his leading role in thinking and talking about the potential problem of deflation several years ago, when he was a Fed governor and economic conditions were far different.
"For bond traders this is the way they remember him," said Ethan Harris, chief U.S. economic for Lehman Bros. "So any time he has opened his mouth and said something that is even slightly dovish people have gone crazy."
For example when Bernanke testified to Congress' Joint Economic Committee in late April and said the central bank would eventually pause in its steady rate-hiking campaign, many forecasters assumed he was signaling the Fed would move to the sidelines in June, and stock prices rose accordingly.
Then, in what Bernanke acknowledged was a mistake, he commented to a CNBC reporter at a banquet that his remarks may have been misinterpreted. When that comment was broadcast, financial markets were whipsawed again.
So Bernanke seems to feel particularly compelled to make clear to financial markets that stamping out any signs of inflation will be his top priority, even if the economy is showing signs of a slowdown.
"He is trying to recover his reputation as a hawk, which he is," said Harris. "There is no question that he is a hawk." As proof, Harris cited Bernanke's support of specific numerical targets to limit inflation, an approach that Greenspan had opposed.
Financial markets are notorious for testing new Fed chiefs early on and demanding proof of their inflation-fighting credibility. The mere fact of a new Fed chief is enough to create nervousness and uncertainty on financial markets, while investors also are jittery about the slowing U.S. economy and the growing confrontation with Iran over nuclear weapons.
But there also seems to be a fundamental communication problem between the new Fed chief and financial markets lulled by 18 years of Greenspan's inimitable speaking style.
“Bernanke came in with this reputation as a great communicator,” said John Caldwell, chief investment strategist for McDonald Financial Group, part of Cleveland-based KeyCorp. “Most of us would choose to go back to the general confusion Greenspan created.”
"There is a hearing problem out there as well as a speaking problem," said Harris. "Financial markets have tended to look at Bernanke and read him through Greenspan's lens. I think over time things will settle down. He will probably soften his tone up a bit and markets will figure out he is more blunt. But right now he has a very strange communication tug-of-war going on."
Harris several months ago predicted that the Fed would continue its rate-hike campaign, a view becoming more mainstream after Monday's speech. Goldman Sachs and JPMorgan are among the investment banks that have changed their forecast and are now looking for the central bank to raise rates for a 17th consecutive time June 29.
Rosenberg, for one, believes that would be a mistake in view of last month's extremely weak job growth and other signs of a slowdown.
"If we see a rate hike after the raft of soft data posted in recent weeks, then we can only draw the conclusion that in the name of rebuilding anti-inflation credibility, the central bank is willing to sacrifice the economy," he said.
But Harris said most central bankers would prefer to overtighten a bit — or "overshoot" on interest rates — rather than let inflation and inflation expectations become embedded in the economy.
"Overshooting is correctable," he said. "Embedded inflation can take years to get rid of."