Keeping One Eye on the Road

Driving a car is an activity where the range of potential distractions necessitates you keep an eye on the road at all times. Whether you're passing a 5 car pile-up or have a screaming child in the backseat, other drivers on the road and passengers in your car count on you to sidestep those distractions and pay just enough attention to the road to arrive at your destination safely. You depend on the other driver as much as you do yourself to remain in one piece.

Much like driving a car, both the market and the Fed must not only be aware of where the other is, but they must also keep an eye on the road - the objective economic environment (outside of the FF rate, bond yields, and equity prices). Earlier today I thought I saw two drivers staring at each other, and not minding the road ahead of them - TickerSense mentioned that (at least) one Fed governor believes in the predictive powers of the yield curve. Now I know that the bond market is fixated on the Fed, but if the Fed were to be staring back with the same focus the situation would be a little uncomfortable.

With the Fed looking at the yield curve, the yield curve being derived from FF rate expectations - who exactly would be doing the driving? This is not to say the Fed should not look at bond yields or consider their impact, but if the almighty Fed believes the bond market can predict future economic conditions then why have the Fed meetings and all their black-box calculations enter into the decision at all? Why not just peg the FF rate to the 10 year? Probably because it would be a disaster. Probably because what makes the system work is that the Fed and the bond market represent two distinct interpretations of the same objective economic conditions that are both necessary. That the conclusions are often the same is not important, often they are not, and what is important is that there remains two separate methodologies for processing data and formulating ideas about the state of future economic affairs. Hopefully the two don't stare directly at each other and they keep at least one eye focused on the road.