Have the Fed’s Attempts at Transparency Become Counterproductive?
The big news last week was, of course, the September labor market report, which showed the economy having created 156,000 new non-farm jobs, slightly fewer than expected, while the unemployment rate edged higher to 5.0 percent as more people looked for work. The question on everyone’s mind was what impact the report would have on expectations for the next Fed rate hike. As it turns out, those expectations rose fractionally for an expected rate hike at the Fed’s December meeting, to 64.3 percent after the report, up from 63.6 percent the day prior. There was a similar move higher regarding the February, 2017 meeting from 65.9 to 67.2 percent. In other words, the report was just good enough to keep expectations on track for a year-end rate hike.
Given the importance of monetary support to this economic recovery, the focus on the Fed and its intentions is certainly understandable. It has been left on an island by fiscal authorities to support economic growth on its own. And there is increasing discussion as to whether the effectiveness of that reliance is running its course. But, there is also a parallel discussion taking place as to whether the Federal Reserve has developed something of a credibility problem. There are several facets to this question.
One concern is the Fed’s continuous overestimation of the expected pace of economic growth and the future trajectory of interest rates. The second relates to the Fed’s use of communications to guide market expectations, only to be forced time and again to back off in the face of softer than expected economic data. At the start of this year, for example, the Fed was talking about the possibility of four quarter-point rate hikes. But a combination of volatile markets, weak data and the Brexit vote have resulted in the greater likelihood that one quarter point hike is all that we will see. This same scenario of preparing markets for a rate hike through hawkish rhetoric only to defer played out once again with the Fed’s September meeting.
The Fed’s Evolution of Communication
The Fed’s communications have evolved over time, and the pace of change has accelerated in the wake of the financial crisis. Prior to the mid-1990s the Fed said nothing in conjunction with Federal Open Market Committee (FOMC) meetings. Investors had to wait for money supply data to infer the Fed’s intentions. It was not until February, 1994 that the Fed first issued a statement following an FOMC meeting, and not until February, 1995 that the decision was made to issue a statement following each meeting at which a change in policy occurred. In July of that year a general target level for the Fed funds rate was included. In May, 1999 the decision was made to issue a statement after every meeting, whether a policy change was made or not and soon began the practice of referencing a specific fed funds rate target.
The length of the statements has evolved as well. The first statement in 1994 was a total of 99 words. The most recent statement in September was five times as long. And the sophistication of the language has changed. Starting in 2000 it included an assessment of economic conditions and risks, and forward guidance related to policy. In 2004 the Fed accelerated the release of meeting minutes to three weeks after each meeting. In 2007 it increased the frequency of its economic forecasts from two to four times a year. In April, 2011 the first press conference by the chairman following an FOMC meeting took place and occurs regularly four times a year. In January, 2012 the Fed began publishing FOMC member forecasts of the level of Fed funds. Add to all of this the frequent speeches and media appearances by Fed officials, either expressing their own opinions or as suspected proxies for the Chair, and it seems that we have inadvertently created a Tower of Babel of Fed speak.
Fed Officials Remain Dependent on Data
In fairness to the Fed, it has insisted right along that its decisions are data dependent and it is right to resist the temptation to enact a rate hike simply in the name of credibility. In an environment of extraordinary policy implementation it’s also right to at least attempt to use every tool at its disposal, including forward guidance. But the question remains whether its attempts at transparency have become counterproductive, that it now communicates too much, with too many disparate voices.
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- Chief Market Strategist, Ameriprise Financial
- More than 30 years of experience in the investment management industry
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