When Federal Reserve Chairman Jerome Powell wrapped up his debut Federal Open Market Committee meeting press conference last March in 45 minutes flat, his plain-speaking, to the point and no more performance was seen as a refreshing change, marking the arrival of a new style of central bank communications.
But a six-month long honeymoon free of critical comment came crashing down in a sequence of messaging miscues since early October that has left many in the markets quietly grumbling over a new “Powell risk” in confused Fed policy communications.
You live, you learn.
Four broad points, followed by a take on the backstory to frame the shape of the Fed communications strategy going forward:
*** While playing down any lasting damage, Fed officials are aware of the risks to the central bank’s credibility in the seeming slips and mixed signals and are working towards a tighter messaging discipline. With the January FOMC meeting presser approaching, for instance, our sense is of more thorough preparation and coordination with the rest of the FOMC on policy messaging takeaways. A greater effort is also likely to more clearly distinguish between the target audiences in the communications aimed at the markets and the financial press versus the wider public in the more general “moderated discussions” that are intended, in part, to win public support for the Fed’s operational independence. ***
*** Policy communications is indeed a central feature of the ambitious review soon underway in public meetings to be held across the Fed districts and in the subcommittee work under Vice Chairman Richard Clarida. In addition to assessing the Fed’s policy framework, the subcommittee may also look at revamping the Summary of Economic Projections and rate dot plots to, among other potential changes, better convey the uncertainty around the base case forecasts with confidence bands and probability distributions. The Chairman’s opening introduction before each FOMC meeting presser is also evolving into a more detailed elaboration of the shortened statement being shorn of formal forward guidance. ***
*** Weaning markets off forward guidance is proving to be especially challenging for the Fed. And no where has that been more apparent than the recent confusion over balance sheet policy amid the still uncertain impact of tightening in shrinking the balance sheet and the unpredictable ways market structures and trading liquidity have been altered after the years of worldwide QE. Going forward, a signposting of the progress in the complex internal debates on the eventual operating framework and optimal sized balance sheet will feature more prominently in Fed communications, with a possible update to the “Policy Principles,” perhaps as soon as the March or May FOMC meetings. ***
*** Even more challenging for the Fed messaging through the near period of an expected “patient pause” on rates will be the careful management of financial market expectations and risk appetite. The tightening in financial condition last fall has nearly reversed since the Fed’s backpedal to a more dovish policy stance, for instance, and could quickly become “frothy” again in a period of a rates pause. The debut of a bi-annual Financial Stability Report may prove to be one of the more significant marks of the Powell leadership in underscoring a much more active attention on the feedback loop between the financial markets and the real economy and, in turn, how monetary policy may need to be calibrated to counter imbalances beyond just inflation. ***
The Long Honeymoon
In the hand-off of the Fed leadership from former Chair Janet Yellen to Chairman Powell, a change in style and policy messaging quickly became apparent in Powell’s first briefing to the press as Chairman in March last year.
Befitting the arrival of a non-academic to the Chair, Yellen’s carefully phrased, methodically prepared and extended answers were replaced by Powell’s more relaxed manner of plain speaking, tersely given answers with little nuance. The press conference ended in 45 minutes flat, unheard of in the scores of press conferences ever since former Chairman Ben Bernanke introduced quarterly press conferences to go with the SEP presentations in 2012.
But behind the change in style, Powell still continued with Yellen’s extensive consultations with each of the Committee members in the black-out week before the formal FOMC two-day meeting. The thoroughness of Yellen’s preparations that proved so effective in helping the Chair craft a Committee consensus has since been essentially institutionalized into the Fed’s collegial culture. Notably, Powell has not had a dissent yet in the seven meetings he has chaired.
There was also an important communications shift that began right away in that first March meeting. While the Fed was still presumed to be still pretty far from reaching a desired neutral level of the policy rate, Powell wanted the Fed to begin its gradual “taper” from the years of the formal forward guidance in the meeting statements, just as it had gradually tapered its large scale asset purchases.
So in March of last year, the boilerplate dovish sentence Yellen had succeeded in winning Committee support for inclusion in her first statement as Chair in March 2014, that rates may be held “below normal” levels of neutral “for some time,” was taken out of the statement.
By late summer, the Powell-led FOMC also began a slow transition to communicating its policy stance for maximum flexibility by introducing a “for now” into the policy phrasing. There were a number of unusual new cross currents likely to complicate the forecasts and modeling assumptions come the autumn months — trade effects; the extent of the fiscal stimulus; the uncertain evolution in inflation dynamics; lagged effects of rate hikes, and; the unknown tightening effects in the balance sheet run-off (SGH 8/20/18, “Fed: Jackson Hole, For Now”) that would also be articulated in Powell’s seminal “celestial stars” speech at Jackson Hole in late August.
In September, the FOMC took out the “policy remains accommodative” sentence in the statement that neatly mirrored a solidly hawkish tilt to the Committee consensus with growth nudged up, a very modest inflation overshoot penciled into the projections, and a median of three more rate hikes being built into the forecasts for 2019.
A “Long Way from Neutral, Probably”
The smooth communications set-up in the Fed’s approach to a neutral policy stance by year-end went awry almost immediately after the September meeting, beginning with the first of Chairman Powell’s “moderated discussions” — this one with PBS veteran journalist Judy Woodruff in early October when, asked about the neutral policy rate, he offered that the Fed “was a long way from neutral at this point, probably.”
It was like a bombshell out of nowhere, quickly turning into spiking yields and a deep swoon in the stock markets. Powell did add that “probably” at the end as though a quick afterthought to reach for a quick fix, but the damage was done.
It was also somewhat confusing to the markets to hear Powell framing the policy debate in terms of neutral after he had seemingly gone out of his way to underplay its importance in the constellation of those celestial stars like neutral, NAIRU, and the output gap in guiding Fed policy going forward that had featured so prominently in the Jackson Hole speech. And New York Fed president John Williams had underpinned that messaging by shortly following Jackson Hole in publicly backpedaling from a virtual career in research focused on neutral estimates.
Part of the problem — one that would resurface again in January when again, speaking without notes, Powell noted the balance sheet will need to be “substantially smaller” — was the absence of preemptively forewarning the market of the intent behind the public outreach.
A key feature of the newly evolving Fed communications strategy has been to take advantage of Powell’s ease in public speaking and more natural, plain speaking style to broaden the Fed’s audience through a series of more generally themed moderated discussions. By design, the unspoken ambition is that such a sustained public outreach effort will help build a broader base of public support to blunt any erosion of the Fed’s credibility and operational independence from the escalating assaults on Powell personally and on the Fed’s independence on rates policy from President Trump.
But while the idea may have been to aim for a broader audience with Woodruff, Powell is still The Chairman. with the market still grasping at every word or nuance of phrasing, and it was a nasty shock at a sensitive moment amid what were already increasingly anxious markets that was pricing well under the rate trajectory mapped out in the Fed’s rate dot plots.
In a way, it was an eerie echo of the Fed’s February 1994 quarter point rate increase that came to be described as the “biggest margin call in history” in triggering a spectacular market rout. But even then it wasn’t so much the quarter point rate increase that did so much of the damage in hindsight, but rather it was the Fed’s failure to let the markets know in advance of its new communications policy to issue statements after every meeting to bring to a close the practice of rate changes being gleaned from a close reading of the Open Market Desk operations in fed funds markets
In the weeks that followed the Woodruff interview, if truth be told, the market turbulence was not entirely unwelcomed. However it may have been unintended, in that the sell-off pushed the stock market down from “stretched” valuations and helped to lift a still repressed term premium, and tightened financial conditions. In turn, it was also tempering the risks of “financial excesses,” a term that was increasingly finding its way into the remarks by Powell and numerous Fed officials on the “imbalances” in the economy alongside inflation.
That episode also provided another useful lesson for Fed officials at the time. Almost throughout the long ascent in the policy rate since the rates lift-off in December 2015, there had been chatter of a redux of the “conundrum” that had run through the course of the 2004-2006 measured rate increases, culminating in a steady swell of speculation over a flattening yield curve that threatened to invert. But in the weeks after the Woodruff neutral remark, the lagged effects of the rate hikes up to then were suddenly leaving their mark in rapidly tightening financial conditions.
While some Fed officials were initially a little anxious the sudden tightening in financial conditions could become a smaller scale version of the 2013 “taper tantrum,” the events of October also underscored for many Fed officials the merits of the “sooner and slower” tactical approach Yellen had mapped out in the start of the rates normalization process in 2015; and, in turn, it subsequently put an accent on the virtue of “patience” in having already preemptively lifted rates ahead of the assumed inflationary pressures that would surface, in time, with the tightening labor market.
And finally, in some fashion, there was expected to be a market repricing of risk as the Fed shifted from the gradual pace of rate increases to a more potentially varied “data dependent” path for policy as the Fed nudged the policy rate to the bottom end of the range of neutral estimates.
That “broad range of estimates for neutral” was to be a key bridge between the “probably” of the early October Woodruff remark and the carefully inserted “just under” phrasing of Powell’s late November Economic Club of New York speech: both statements are factually correct, but the intention was clear, and the markets quickly responded by reversing from the bearish pricing and grumbling since October to surge back north once again.
A Hawkish December, Dovish Minutes
Those volatile swings, however, would be repeated in an even more spectacular volatility after the December FOMC meeting and press conference right through the holidays and into the new year.
In the December meeting, the FOMC issued a statement and rate dot plot that was almost right on expectations, a rate hike but with a softer takeaway in the forecast, and a median rate projection for 2019 that was brought down from three to two. Powell also seemed to do his best to convey a more dovish spin to what was a hawkish lean in a modestly more divided Committee that opted to keep the statement’s forward guidance, indicating more rate hikes were still likely even if the more conditional “judges” and “some” further language was added to soften the blow.
The efforts to control the policy narrative were, again, to no avail, as an already skittish market only took away that “two more hikes were coming,” not that the Fed was backing away from the more hawkish stance of September. Worse still was the effect of Powell’s almost casual observation that the Fed’s balance sheet policy was “working well” and would effectively remain on “auto pilot.” The market nosedived literally within minutes.
In hindsight, it was a stunning communications own-goal that suggested the lack of a briefing, particularly by New York, which is supposed to be the Board’s “market eyes and ears,” that there was a building mood in influential quarters of the market that the “paint drying” aspect of the asset run-off from the balance sheet was in fact tightening financial conditions far more than the Fed was assuming, to the extent of exacerbating market volatility by pulling liquidity out of the stock market. There was even a high profile op-ed along those lines in the Wall Street Journal on the eve of the meeting.
That most Fed officials across the Fed system are deeply skeptical of such arguments (see SGH 12/21/18, “Fed: The Balance Sheet Question”) is ultimately almost besides the point: if enough in the market believe otherwise, then the balance sheet policy is tightening financial conditions more than the Fed is assuming or the models say it is. By default, the issue had to be addressed head on.
New York’s Williams was again sent out to correct the misfire less than two days later on Friday morning, offering the reassurance the Fed would be sensitive to the balance sheet effects, and he was followed by virtually the entire Committee offering reassurance of potential flexibility if needed without actually addressing the specific issue of the asset run-off, and which high quality liquid assets would be chosen to replace the loss of reserves with the banks or its impact on risk appetite.
“Patience” and Two Issues Going Forward
Kansas City President Esther George earlier this week then neatly summarized the thrust of the Fed’s policy messaging that could be edited down into a single word: “patience.” By positioning rates on the edge of neutral, and with muted inflation as the backdrop, the Fed can well afford to step back on its policy stance to better gauge the lagged effects of the rate hikes to date and to see how the data plays out.
That they can be so patient over what Chicago Fed President Charlie Evans suggested could well be some six months has been repeated so often — New York’s Williams repeated it several times in his speech this morning on the eve of the black out before the January 30-31 FOMC meeting — that it is triggering no small amount of speculation there was an inter-meeting conference call to hone the policy messaging and to get the story straight going into the new year.
But we would only note two potential complications to the Fed’s communications during this likely extended “patient pause” into the late spring, barring data shocks in either direction:
The first is the balance sheet debate becoming a central feature of the communications going forward. The “boring as watching pain dry” period of the balance sheet normalization is now over. A version of what former New York Fed president Gerard Corrgian used to call a “constructive ambiguity” is now the fall back balance sheet communication in the wake of the December “auto pilot” messaging misfire; namely to offer flexibility on the pace of the asset run-off, implying that it could be driven by concerns of excessive tightening that the market wanted to hear so dearly.
The soothing words do buy the FOMC time to work towards its decisions on the eventual operating framework. But at least for now, whatever its estimated effects, the still very solid Committee consensus is to make any necessary adjustments in the policy stance through interest rates, not the balance sheet.
The priority on the balance sheet policy remains a focus on right-sizing its securities portfolio and better understanding the demand for reserves. Any slowing or reversal in asset run-offs will be defined by the assessment of where the size of the securities portfolio needs to be in order to meet the demand for reserves and to efficiently execute monetary policy.
The balance sheet as a policy tool to “fine tune” the degree of monetary tightening is positively not on the Fed’s agenda, in other words, and that is likely to be a consistent point target in the policy remarks by all the Committee in the weeks and months ahead to narrow the gulf between market expectations and Fed deliberations on the balance sheet.
The other issue is even more problematic and reaches even more deeply into the coming discussions and debate through this year on the possible and needed changes to the Fed’s overall policy framework.
Much of the academic debate so far has been over the continued viability of the 2% inflation target, whether to double down on its symmetrical, flexible features, or to adjust it up to 3% or even 4%, or adopt a more aggressive price-level targeting regime, or (more likely) to embrace a milder but flexible inflation averaging over a business cycle.
But an even more pressing question in the framework debate may prove to be the relationship between monetary policy and the rapid risk-on/off trading and investment patterns of the financial markets that can often be dislocating and spill over into the real economy. The introduction of the new Financial Stability Report late last year was just one sign of the more active attention the Powell-led Fed is putting on the transmission channels and feedback loop between the financial markets and the real economy.
And as a consequence, managing the twist and turns of the seeming symbiotic relationship between the calibrations of monetary policy and the gyrations of rapidly repriced risk in the financial markets is invariably going to feature prominently in the Fed communications in the near term period of a patient pause, in pursuit of a soft landing for the real economy.