When I started in banking in the mid-1970s the Federal Reserve said nothing — literally.
There were no press conferences, no timely release of board minutes and no policy speeches (if a governor or reserve bank president gave a speech, it was commemorative only).
Mandated congressional testimony consisted of incoherent mumbling behind clouds of cigar smoke perfected in various ways by Paul Volcker and Alan Greenspan. Fed officials were no more animated than the marble facade on their headquarters on Constitution Avenue in Washington, D.C.
In the 1970s, “Fed watching” was an art form as opaque and nuanced as Kremlinology. (Scholars of Soviet behaviour in the 1970s studied ceremonial photographs of officials atop Lenin’s tomb to measure the proximity of those officials to the Communist Party general secretary as way to discern who was “up” or “down” in the hierarchy.)
The Fed would provide leaks, but not to reporters like The Wall Street Journal’s Jon Hilsenrath. Leaks went to a small group of in house economists at the primary dealers — the firms who dealt directly with the New York Fed’s open market desk.
The leaks would be telephonic (before ubiquitous recorded lines) or over drinks near Hanover Square. The only other sources of information were the open market operations themselves.
Astute traders at the primary dealers were supposed to infer Fed intentions from actual transactions. That was the whole idea. Word would spread quickly, and markets would reprice for whatever new direction the Fed wanted to steer.
Ben Bernanke changed all of this. His view was simple. Transparency was good. By clearly stating the Fed’s intentions, markets could form “expectations” about the future path of interest rates.
Those expectations about the future would be translated through present value calculations and discounting into actions today.
If the Fed wanted to ease policy today, they would give “forward guidance” about the future. That forward guidance would translate into present value, and the policy goal would be achieved smoothly and without surprise. Term premia (added interest to compensate for future uncertainty) would be reduced. For academics like Bernanke and Yellen, this was utopia; all frictions eliminated, all anxieties tranquilised.
As with most academic schemes, utopia quickly became dystopia.
Once the Fed chair began making regular public comments about policy, other Fed officials thought, Why can’t us? (in that indelible Philadelphia turn of phrase).
Soon, the speeches became a cacophony. Seven governors (now five, due to vacancies), 12 reserve bank presidents and the head of open market operations couldn’t stop talking. Nuance about whether a reserve bank president was “voting” or “non-voting” seemed lost in translation. A governor like Lael Brainard could be a super-dove in October and a dutiful hawk in December. Whatever.
All that Bernanke and Yellen achieved was to replace one kind of uncertainty (about current policy) with another kind of uncertainty (about future intentions).
Did the Fed really mean what it said? Who was speaking for the Fed? Would the Fed change its mind? If the Fed is “data dependent,” how would they weigh the data? And so on.
Enjoy the rate hike later today, which now looks all but certain. But don’t breathe a sigh of relief. The guessing game will restart immediately.
When is the next hike coming? How frequent will they be? Will the new FOMC be more hawkish or dovish?
In the absence of message discipline (there is none at the Fed), speculation will be more rampant than ever.
That said, not much of this matters to the real economy. The US is heading into a recession, and the Fed’s rate hikes will accelerate that eventuality. Slower growth and deflation will dominate the Fed’s preference for rate hikes.
It will be interesting to see if the Fed hikes once, twice or three times before reality sinks in. The rate hikes will be over soon enough. Expect a new round of Fed easing to “stimulate” a flagging economy by mid-to-late 2016.
No amount of forward guidance will change the hard reality of recession.