How the Federal Reserve conveys its
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"Forward guidance provided by the Federal Reserve can be helpful, if it is accurately done and if they stick to it," said Komal Sri-Kumar, a senior fellow at the Milken Institute and independent macroeconomic consultant. "It is like I come to you asking for directions on the road, if you give me poor advice and send me the wrong way, I'm worse off with the forward guidance. That, I believe, is what has happened with the Fed."
Sri-Kumar said the Fed's forward guidance — both its formal, voted upon policy statements as well as remarks and forecasts from individual officials — has been faulty for years. He said the Federal Open Market Committee's view that inflation would be transitory in 2021 had ruinous consequences for banks that loaded up on long-dated Treasury securities before what turned out to be a run of steep rate hikes.
He and others fear that a similar reversal could happen again. The consensus expectation of financial institutions coming out of the past three FOMC's meetings has been multiple rate cuts in 2024. But recent comments from Powell — that it could take "longer than expected" for the Fed to feel price increases slow down sustainably — have cast new doubts on those projections.
"It's hard to view where interest rates are going, given what the Fed has said recently versus what the expectations were at the beginning of the quarter," said Thomas O'Brien, CEO of the $2.4 billion-asset Sterling Bancorp in Southfield, Michigan, on the company's first-quarter earnings call last week.
Now, companies are shifting guidance or waiting before offering more.
U.S. Bancorp
John Corbett, CEO of SouthState Corp., said on the bank's recent earnings call that the institution was aiming for "flexibility and optionality" amid the economic uncertainty.
"We're all trying to play economists and forecast the yield curve," he said. "We don't have a crystal ball. The only thing we know for sure is that all of our forecasts will be wrong."
Some say this uncertainty, as uncomfortable as it may be for bankers, is forward guidance working as it should by bracing the market for potential changes well in advance. Michael Redmond, a U.S. policy economist for Medley Global Advisors, said the primary issue related to forward guidance in recent months has not been the
"There was a market narrative that got ahead of the Fed," Redmond said. "Maybe the Fed could have done more to extinguish that, but in December, when the Fed was signaling three cuts and the market wanted to price in six or more, the Fed certainly wasn't cheerleading that process."
Meeting by meeting, word by word
During his post-FOMC press conferences, Powell frequently notes that policies are made on a "meeting by meeting" basis and do not have a predetermined policy path. Instead, he notes, the committee's decisions are influenced by the most recent data reports.
But, the financial sector parses the FOMC's communications carefully for insight into how the Fed sees the future unfolding. And sometimes a single word or phrase can, in fact, carry a lot of weight.
"So, we added the word 'any' as an acknowledgement that we believe that we are likely at, or near, the peak rate for this cycle," Powell said during his press conference. "Participants didn't write down additional hikes that we believe are likely, so that's what we wrote down. But participants also didn't want to take the possibility of further hikes off the table."
While the Fed's policy statement is written by consensus — and often supported unanimously — it is not the only insight to emerge from the committee. Some see significant discrepancies between the statement, Powell's press conference remarks and subsequent comments from individual board members and reserve bank presidents.
Sri-Kumar said the Fed's consensus-based approach to policymaking results in guidance that appears more resolute than it actually is, and can make it difficult for outsiders to square divergent views among different officials.
"In the formal meeting, there are no dissents, so you would think all of them feel similarly, except that once they leave the meeting they all go to the press and say various things that are different from the way they voted," Sri-Kumar said. "So the whole picture is very confused."
Redmond said putting out a consensus policy while also acknowledging disparate policymaker views is an issue with which many central banks must contend.
"It's complicated when you have 19 different policymakers who have essentially different weights in terms of importance for the decision, but you also want to make it seem like it's a committee that's coming to a consensus, albeit with some disagreement," he said. "There's not really an easy way of communicating all the nuances that they probably wish they could communicate."
Dipping dots
While Powell's post-meeting comments contributed to the widespread view that the Fed was preparing for a cut, the remarks were not the only communication from the committee fueling this view. There was also the quarterly summary of economic projections.
Also known as the "dot plot" — participant views are reflected as a dot on a chart of potential outcomes — the December report showed 11 of the 19 participants expected the federal funds rate to fall by at least three-quarters of a percentage point by the end of this year, equal to three quarter-point cuts, with one participant anticipating six cuts. The March dot plot showed 9 participants projecting three cuts and one calling for four.
Powell often reiterates that the forecasts belong to the individual participants — not the FOMC as a whole — and are based on present-day data that is subject to change.
"These projections are not a Committee decision or plan," Powell said last month. "If the economy does not evolve as projected, the path for policy will adjust as appropriate to foster our maximum-employment and price-stability goals."
Still, despite these caveats, Derek Tang, co-founder of the Washington-based research firm Monetary Policy Analytics, said financial market participants tend to take SEP projections as something akin to gospel.
"There's a lot of dependence on the dot plot to convey a baseline scenario," Tang said. "The Fed has always said the dot plot is contingent on the economic data unfolding in the way portrayed by the corresponding macro forecasts, but that part is often lost in the conversation."
Following last month's FOMC meeting, most Fed funds futures traders expected at least three rate cuts this year, according to the CME FedWatch Tool, which tracks derivatives contracts related to the policy rate. At the time, the model estimated a 75% probability that the Fed would cut rates three times or more. As of April 25, that probability had fallen below 12%, while the prospect of zero cuts has risen from essentially zero to nearly 20%.
Brent Beardall, CEO of Seattle-based WaFd Bank, said the Fed overshares its dot plots and projections that move markets without certainty in those guides. He added that it's a "fallacy" that the agency can predict the future, and setting expectations can make the economic environment "frothy."
"We go too far in today's day and age," Beardall said. "Let the Fed say, 'Here's the data we have. Here's the decision we have today. Here are the things we're looking at in the future, but we don't know where rates are going to go.'"
Communication breakdown
The idea of forward guidance is a
The policy statement, the summary of economic projects and the post FOMC press conference are all developments of the past few decades. Previously, the committee's policy changes went unannounced and had to trickle through the economy quietly.
The Fed has adopted its various means of communication to smooth the implementation of monetary policy. But there has long been a debate about whether more communication creates a clearer signal or just more noise.
Former Treasury Secretary Larry Summers said the Fed should offer fewer takes on the economic situation to preserve its credibility. Speaking at Semafor's Washington summit earlier this month, Summers said the agency should take a page from the books of longtime former Fed Chairs Paul Volcker and Alan Greenspan on keeping messages accurate and ambiguous.
"The basic lesson of the Delphi Oracles, which is that if everybody thinks you're omnipotent and omniscient, but you're actually human, don't say too much," Summers said. "And keep what you say vague and oracular so that you can preserve your credibility."
John Williams, president of the New York Fed and vice chair of the FOMC, said at the same event that the Fed offers its projections and data, "to help, as best as we can, for the public to see how we're thinking, what's driving our decisions and hopefully align the public's expectations with what we're trying to do."
In response to Summers's comments, Williams added that the data the agency uses today is "dramatically different than the data of the past," providing finer detail more quickly.
Tang said the Fed has an obligation to provide guidance, not only because of the impact of its policy rate, but also because of its large presence in financial markets via its
"They recognize that medium is message here," Tang said. "The way they communicate their forecasts or communicate scenarios can tie their hands a little bit, can impose limitations on the type of guidance that they can give the market and how effective it is."
Still, while the Fed's messaging can confound and frustrate market participants, they don't expect the agency to be clairvoyant.
"It is really easy to be in the cheap seats to sit out here and see what they're doing and to criticize," Beardall said. "They have a very, very tough job to do. But if I were in their seats, I think it would be helpful if I wasn't having to publicly try to predict the future."
