Fed: "Forward Confusion" is New Norm
In a December 2015 statement, the Federal Reserve explained the process and rationale for a policy to start raising rates from near-zero where it had been since the global financial crisis. The central bank’s process, known as “Forward Guidance” was intended to help investors make informed decisions, for financial markets to experience less volatility, and for capital allocation to be more efficient.
Its noble objectives, however, have been observed just as often in the breach than in their observance. Take the case of the Fed meeting on December 19, 2018. In deciding to raise the Federal Funds rate for the fourth time that year, Fed officials gave the signal that two more hikes would follow in 2019. Reducing the number of rate increases from three that had been anticipated to two was intended to be a dovish signal. The stock market did not see it the same way. Equities plunged between December 19 and the end of the year.
That was sufficient for Fed Chair Jerome Powell to pivot. Just two weeks later, at the American Economic Association meeting in Atlanta on January 4, 2019, he walked back his December comments by stating that “with the muted inflation readings that we’ve seen coming in, we will be patient.” Equities rallied. The Fed ended up reducing rates three times in 2019 rather than increasing them, as it had previously signaled. So much for Forward Guidance.
More recently, senior officials contradicting each other on monetary policy during the rest of 2021 has been covered in SriKonomics pieces, here and here. It got more interesting last week as inflation numbers, both at the retail level as well as in producer prices, came out much higher than expected. Consumer prices rose in April by 4.2% compared with a year earlier, the most since September 2008, and the figure was even higher than the markets’ pessimistic expectation of a 3.6% rise.
The Fed’s mantra has been that any pickup in inflation would be transitory. However, the April numbers show sharp increases in prices of commodities, of inputs, and of finished products in a diverse range of sectors. As the economy recovers and prices rise along with it, the central bank continues to be stuck in its groove — continuing to buy bonds at the pandemic level of $120 billion per month, and constantly repeating that inflation will come down toward the Fed target of 2%.
Think of the image of Roman Emperor Nero playing the violin as ancient Rome was burning.
Forward Confusion got fresh support earlier this month when Treasury Secretary Janet Yellen provided two conflicting statements on the same day on what the Fed should do. She has since had company. Fed Governor Lael Brainard, who led the Fed’s Financial Stability Report that warned May 6 about increased systemic risk from excessive borrowing and low interest rates, gave a different point of view last week.
In a pivot of her own, Brainard suggested May 11 that the Fed be patient with what she called a transitory pickup in inflation. She wanted to ensure that markets understood that easy monetary measures would continue. Dutifully, after a correction midweek due to the high inflation numbers, the stock market rallied to close the week.
All this makes your head spin? Your tax dollars are at work as Fed officials add to the Forward Confusion. Enjoy!
Komal Sri-Kumar
President
Sri-Kumar Global Strategies, Inc.
Santa Monica, California
May 15, 2021
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