The Fed has a public relations problem.
In an effort to rein in overheating inflation, the Fed has sought to signal to investors and financial markets its plans to deal with rapid price growth. For monetary policy and rate hikes to work, markets must clearly grasp and align with the Fed’s goals. But recent communications from Fed Chairman Jerome Powell and other Fed officials have been confusing at best—you just have to look at the big shifts in markets over the summer to see if mistakes have been made.
It’s not just a problem with Powell and the Fed, it’s a problem with the economy. If investors stop listening to the Fed, even a perfect decision by the Federal Open Market Committee (the Fed’s main rate-setting committee) can lead to tragic missteps that are too hawkish or too dovish. To actually implement the tightening measures needed and lower inflation without losing control of the process, the Fed needs to clean up the way it communicates with the markets.
play the expectation game
Markets are forward-looking in nature, predicting a company’s economic growth in the future or years ahead.In order to move the economy towards the outcome it wants, the Fed has turned to Financial status. As economic conditions change, markets will consider what the Fed and other central banks will do next. By signaling future rate cuts, the Fed hopes to send a signal that leads businesses to hire and invest while households spend more — boosting the economy. In signaling an imminent rate hike, the Fed wants to slow asset price growth and dent confidence, thereby reducing spending by consumers and businesses.
Using financial conditions to regulate the economy has proven extremely useful to the Fed in the past. After the global financial crisis, interest rates were already at zero, so the Fed’s ability to boost the economy was limited.One solution is to communicate an intention to keep interest rates low until the economy takes hold, a strategy called Forward Guidance. Forward guidance means the market can price in low rates long into the future, which helps keep stocks strong and mortgage rates low, even if the Fed can’t lower rates any further.
Other times, the signal didn’t go away either. When the Fed started raising interest rates in 2004, the cost of debt for the private sector actually became more accommodative. From June 2004 to September 2005, corporate bond yields and mortgage rates both fell by about half a percentage point, while the Fed’s main rate rose from 1% to 3.75%. Markets failed to understand the situation, and as a result, the Fed’s efforts to slow economic growth and make the expansion of the 2000s more sustainable failed. Arguably, this failure made the global financial crisis recession worse than it otherwise would have been.
What we encounter here is the inability to communicate
Today, the Fed and other central banks around the world are trying to tell the market they intend crunch policies to control inflation. In theory, the result is a cooling economy and lower prices. But instead of guiding markets with clarity or useful ambiguity this summer, the Fed has helped them with a slew of confusion and contradictions. Statements by Powell and other members of the FOMC are mutually exclusive or divergent from previous communications. That creates a dangerous wedge between what the Fed wants and what the market expects. Even scoring on the curve, there have been some glaring miscommunications this summer, suggesting a need to rethink communication methods.
Take the June FOMC meeting, for example: Although the Fed has signaled for weeks that they plan to raise rates by 0.50%, The Wall Street Journal reports Days before the meeting, the Federal Open Market Committee planned to raise interest rates by 0.75%, the largest rate hike at a meeting since 1994. Explaining the sudden shift, Powell pointed to a survey showing Americans’ expectations for future inflation are too high and comfortable.But this investigation A sample of only a few hundred people It was later revised down and proved to be a false alarm.
Powell was stumped on the Fed’s most closely watched inflation gauge: headline inflation, which includes volatile commodities like energy and food, or core inflation, excluding those categories to try to gauge underlying price pressures. At the June meeting , Powell answered a question about what kind of inflation the Fed is targeting with a clear “inflation means headline inflation.” But a month later, as gas prices and food prices began to fall, Powell turned to saying that “the core is actually a better headline and an indicator of all inflation going forward” — the same as in his last meeting.
Disgraced market watchers may roll their eyes at anyone disappointed when Fed officials say it out of their mouths. But those same gray-haired market watchers may have been baffled by Powell’s prepared remarks at the July FOMC meeting, when he said “slowing the pace of rate hikes may become appropriate.” It is a logical statement of fact that the fastest pace of austerity in decades will not continue indefinitely. But by making it clear, Powell gave the market an opportunity to take on more assumptions.
These flip flops created confusion in the market. Stock prices tumbled after the mid-June meeting, but surged after the subsequent meeting, appearing to signal that the most drastic rate hikes are over. The yield differential between high-risk and low-risk bonds has also narrowed. This sounds like good news, but it actually represents a breakdown in the way monetary policy is communicated to the rest of the economy.
To correct the market’s assumption that the worst of the rate hikes is over, Powell and other FOMC members have spent weeks trying to convince investors they are still committed to raising rates to keep inflation in check. At his annual economic policy symposium in Jackson Hole, Wyoming, in August, the chairman sought to reverse market moves in late July and early August, sternly reminding his audience that lowering inflation would require the Fed to “bring some pain” to the economy.
That’s not to say all markets aren’t following the Fed’s path. Yields on two-year notes, which roughly represent the market’s pricing of the federal funds policy rate over the next 12 months, have risen steadily. While intermittent, the transition from a rate of less than 0.75% late last year to nearly 4% today has been remarkably smooth and steady. But the orderly movement in Treasuries compared to the repeated chaos in stocks and corporate bonds only underscores the Fed’s inability to develop its plans.
The good news is that bond markets are confident that the FOMC will succeed in reducing inflation, while surveys of consumers and businesses show that inflation expectations have fallen along with gasoline prices over the past few months. The Fed is credible in the long run, but the FOMC has made life harder for itself by changing its script.
Clarity above all else
This summer brought a clear lesson to the FOMC: Communication wasn’t working properly.A clear forecast or a specific focus is
Penalized by volatility and unbalanced positions. Overall, less communication would be good for the Fed.
Since I started tracking all public comments from FOMC members in June 2017, Fed spokespeople have spoken publicly on average more than once a day — and that doesn’t include Fed minutes and policy decisions or similar press releases. Powell also began holding interest-rate news conferences eight times a year, double the number in 2018. If FOMC members said much less, there would be much less room for confusion.
It has been helpful for the Fed to repeatedly and publicly discuss its policy approach when it is not under pressure to tighten quickly. As the economy changes, Fed communication is imperative. Less is more – and enough to meet the goal of informing the market and the public without causing confusion.
George Pearkes is a global macro strategist Custom Investment Group.
