Overshadowing the Fed’s decision not to boost rates at last week’s FOMC meeting was the central bank’s declaration that it would “‘be patient’” in determining its future course of rate hikes — messaging Fed governors have reinforced in several speeches since.
Surprisingly, the Fed also showed a greater willingness to moderate its balance sheet runoff. The developments buoyed markets, with the S&P 500 rising 1.6%. Odds of a 2019 rate hike plunged below 10% as markets anticipated the Fed’s next move would more likely be a rate cut in 2020.
However, developments in the intervening days suggest markets’ reading of Fed chair Jerome Powell’s carefully worded statement may be overly optimistic. Among the drivers of the policy shift, Mr. Powell cited easing inflation concerns due largely to declining oil prices. Since bottoming on December 24, though, brent crude has risen 20%.
While remaining cautious, Mr. Powell’s speech stressed that US economic fundamentals show continued strength. Recent data buttresses that stance. Friday’s jobs report delivered a major upside surprise with a gain of 304,000 jobs — nearly double the expected increase of 165,000.
Wage growth models are predicting accelerating labor costs, and the ISM Manufacturing PMI report also exceeded forecasts. Companies have also posted stronger-than-expected Q4 earnings thus far.
In addition, the Fed’s dovish tone may have been a product as much of necessity as of contemplation. Aftereffects of the US government shutdown include “murky” data on key measures such as GDP, retail sales, and housing, leaving the central bank more likely to course-correct as new data becomes available.
Last week’s post-meeting speech was the latest loop-de-loop on a communications roller coaster for markets and the Fed. Stocks plummeted 8% in the days following December’s rate hike after Mr. Powell “sought to highlight the economy's strength.” Equities recovered all of those losses in the weeks after Mr. Powell walked back his comments on January 4.
That back-and-forth highlights a plethora of paradoxes around recent Fed policymaking. Even as the agency has sought to improve the transparency and predictability of its decision-making, markets have grown more rather than less sensitive to policy statements.
Behind that trend, the Fed’s well-intentioned “effort to demystify” its actions “to strengthen its standing with the general public” has, ironically, stoked uncertainty. Mr. Powell has sought to be more communicative — doubling his slate of 2019 post-meeting speeches — as well as more “plain-spoken,” and he has ad-libbed answers to questions more than his predecessors.
Those efforts have seemingly backfired as investors struggle to interpret a profusion of generalizations about Fed policy.
Fed governors have also been called upon to give more high-profile speeches to clarify the central bank’s positions. But governors’ varying rationales and dissenting opinions likewise have the potential to blur rather than sharpen the focus of the Fed’s messaging.
Donald Trump’s increasingly vocal attacks on Fed rate hikes have exacerbated muddled messaging by compelling Mr. Powell to embark on a “charm offensive,” increasing his visibility and, by extension, his exposure to off-the-cuff slip-ups.
That said, a measure of responsibility also lies with investors, who’ve increasingly demanded certainty from a Fed faced with the paradoxical task of clearly conveying uncertainty.
Former Fed vice-chair Donald Kohn recently noted that Fed efforts to provide clarity through simplifying metrics such as median projections have obscured the give-and-take in the inherently nebulous craft of economic forecasting.
As markets hang on the Fed’s every word, so are central bankers around the world parsing the Fed’s blueprint for conveying policy with keen interest in an era of unprecedented speed and breadth of communication. For them, the key takeaway may be that simplicity carries the day — except when things get complicated.