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Some commentators are pressing the Federal Reserve for more specific guidance — forward guidance, that is — at the conclusion of the two-day meeting on Wednesday.
It’s not clear why more hand-holding is needed or warranted — or even advisable.
Is there anyone on the planet who hasn’t heard that the Fed will do “whatever it takes” to support the economy and keep financial markets functioning in the wake of the Great Lockdown, now an officially designated recession, in response to the coronavirus?
Perhaps it’s not clear what Fed Chair Jerome Powell meant when he said on May 13 that the Fed “will continue to use our tools to their fullest until the crisis has passed and the economic recovery is well underway.”
More Fed coverage: Fed will be encouraged by the May job-market surprise but unlikely to rip up its low-rates-for-longer script
Or maybe folks missed the Fed’s announcement of an array of emergency lending programs to support markets for federal government, mortgage, corporate and municipal securities, not to mention small and midsize businesses.
The stock market SPX, -0.52% , which has been on a tear since bottoming on March 23, clearly isn’t crying out for more explicit guidance.
Whenever I write about forward guidance — a policy tool designed to influence market rates by promising a specific level for the funds rate — I hark back to the advice of former Fed Vice Chair Stanley Fischer. Fischer said it’s unreasonable to expect the Fed “to spell out what it’s going to do… because it doesn’t know.”
In other words, crystal balls are inherently cloudy.
Recent history supports Fischer’s caution on, and the value of, gazing too far out into the future or being too specific about future policy actions.
The Fed raised its benchmark rate four times in 2018, a total of 100 basis points, in conjunction with its balance-sheet runoff.
Its December 2018 rate hike and intimation of more to come precipitated a violent sell-off in the stock market, after which Powell turned on a dime and started preaching “patience.” The balance sheet runoff, which he had said was on “autopilot,” was soon terminated.
As it turned out, the stock market had the better forecast. By July 2019, the Fed’s patience had run out, and it started lowering rates.
Fed officials are reportedly considering an enhanced form of forward guidance that would tie any future rate changes to the realization of economic thresholds, such as a prescribed unemployment and inflation rate, or to calendar dates. No enhancements to forward guidance are expected to be announced this week, however.
The last few years have witnessed a peaceful coexistence between low unemployment and low inflation, contrary to the relationship described by the Phillips Curve. In the wake of such evidence, why would the Fed want to commit to specific numerical thresholds until it has a better grasp of the phenomenon?
The Fed is also exploring an additional policy tool to augment its near-zero interest rate and aggressive bond-buying program.
A strategy called yield-curve control would entail capping short- and intermediate-term yields at a desired level, buying securities in the amounts necessary to keep them at the target.
The problem with yield-curve control is simple. There is vital information in the yield curve. Any attempt to distort the slope of the curve deprives policy makers of guidance: guidance they need, not guidance they offer.
The juxtaposition of an artificially pegged rate (the funds rate) and a market-determined interest rate provides a succinct snapshot of the stance of monetary policy. Tinkering with the term structure deprives the Fed of an early-warning signal indicating whether policy is too tight (an inverted curve) or too easy (an ultra-steep curve).
Why would the Fed want to give that up?
A handful of Fed governors and bank presidents have acknowledged the predictive power of the term spread — at least until it inverts and they find all kinds of reasons to dismiss the message that policy is too tight. (See: This time is different.)
Long-term rates had been tumbling throughout 2019, narrowing the term spread and finally inverting it in May. Policy makers did get the message this time, albeit delayed, and started to cut rates in July.
No one would argue that transparency is bad or that the Fed should revert to its pre-1994 policy of not announcing policy changes. But there is a clear middle ground, where the Fed outlines its objectives and projects what it thinks is necessary to achieve them over a reasonable time frame. Meanwhile, the search for an infallible policy rule will continue.
Right now, forecasting has become diceyer than ever. There was a record 10 million miss between expected non-farm payrolls and actuality last Friday. For that reason, the White House will forego publishing updated economic projections with its mid-session review this summer. In this kind of environment, is there any value in the Fed providing guidance years out?
Under the circumstances, I turned to my Magic 8-Ball and asked for its economic outlook.
It gave me a succinct answer: “Reply hazy. Ask again later.”
