This is just quick note to consider how Fed speak might evolve. Basically, I realize that given my recent push to highlight the hawkish aspects of Fed policy, I might be exposing myself to the risk of seemingly dovish Fed speak. This is a good time to reflect on what we might see from Fed communications in the coming months.
I see this Reuters story wondering if the Fed will react to the rise in long term yields. So far, it is just noise, at least according to Cleveland Federal Reserve Bank President Loretta Mester:
“The fact that interest rates moved on one day is not a concerning thing. Markets are volatile,” Cleveland Fed President Loretta Mester said, adding that strong payroll data and perhaps this week’s U.S.-Mexico-Canada trade agreement provided a boost to bond yields. “It is still appropriate for us to be moving interest rates up gradually,” she said.
That sounds right; the magnitude of recent Treasury moves should not be considered disconcerting, particularly if they reflect a more optimistic growth scenario. That said, the exit from forward guidance poses a communications challenge not only for Fed watchers and market participants, but also for central bankers. One benefit of explicit forward guidance is that it directly communicates the policy stance, thereby reducing the odds crossed wires between financial markets and the Fed. The intended effect of adding uncertainty into the picture by pulling forward guidance has the consequence that the Fed may have difficulty communicating their message.
The upshot is that we might see apparently conflicting messages if the Fed feels that the market has drifted too far away from the central story. It will be different than the “cacophony of voices” problem; this will be evident possibly from even a single voice. Note already how easily New York Federal Reserve President John Williams pivoted away from r-star. And I keep hearing complaints that Federal Reserve Chair Jerome Powell is “all over the place,” seemingly hawkish on one day and dovish the next. These transitions might appear more stark if, for instance, the Fed feels they need to rein in rate hike expectations.
Another way to think about this: In my view, Powell & Co. currently spend something like 50% of their time living in the 1970’s, 40% living in 1994-95, and 10% in the Great Recession. So most of the time they will be bouncing between worries that need to keep enough pressure on rates to ensure inflation remains contained and worries that the long end of the bond market shoots higher due to excessive rate hike expectations. The message might thus bounce back and forth accordingly.
Personally, I am looking forward to the post-forward guidance era. I think it will be much more fun and interesting. But I understand that not everyone will share that opinion.
Bottom Line: My approach to the post-forward guidance era centers on paying extra close attention to handicapping the Fed’s forecasts in light of how incoming information impacts those forecasts. For instance, look at the initial unemployment claims numbers, a forward looking indicator that provides no hint of a shift in the labor market. That’s hawkish in that it confirms the forecast (which is more aggressive than market implied forecasts). Think of the Fed speak as trying to push us back to that approach. It might seem clumsy at times, but that is just what you need to expect in the absence of a more explicit communication strategy.