US economy

The Fed rumour mill


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Good morning. Fed day! Everyone now expects a 75 basis point interest rate increase; a week ago almost no one did. Some thoughts on how that came about, below. Send along your thoughts on Fed communications: robert.armstrong@ft.com and ethan.wu@ft.com.

Credibility is no reason to do bad policy

Here is the Federal Reserve’s policy about pre-meeting blackout periods:

To facilitate the effectiveness of the committee’s policy deliberations and the clarity of its communications, participants will observe a blackout period on monetary policy communications in conjunction with each regularly scheduled committee meeting. The blackout period will begin at the start of the second Saturday (midnight) Eastern Time before the beginning of the meeting and will end at midnight Eastern Time on the next day after the meeting . . . During each blackout period, participants refrain from expressing their views about macroeconomic developments or monetary policy issues in meetings or conversations with members of the public.

We have learned in recent days that almost no one on Wall Street believes the Fed followed this policy in the run-up to today’s meeting.

What people believe, instead, is that the Fed really had something to say, so it called The Wall Street Journal, and The Wall Street Journal wrote a story saying that the Fed was “considering” that thing. The consensus view is that this is what happened on Monday, and that the wild moves in the market late on Monday were the direct result. (I have no hard information about this. Is it possible everyone on Wall Street is wrong about this at the same time? Weirder things have happened.)

The story said that the Fed was really, really thinking about announcing a 75bp rate increase today. Here is the lead:

A string of troubling inflation reports in recent days is likely to lead Federal Reserve officials to consider surprising markets with a larger-than-expected 0.75-percentage-point interest-rate increase at their meeting this week.

The use of “surprising” here is of course deliciously ironic (and the sentence strictly speaking false) if the prevailing account is true and the story was a leak. Because surprising markets at their meeting is precisely what the Fed decided not to do. They wanted to give a very strong hint before the meeting, so markets wouldn’t be surprised.

Two questions leap out here.

One, is this all quite stupid? Does it matter if the market is shocked on Monday, by the WSJ, or today, by a Fed press release? Honestly, why bother?

Two, does the hilarious, clumsy transparency of the whole ploy erode the Fed’s credibility? The Fed has prided itself on deliberate, gradual messaging. Will the Fed’s words carry less weight in the future? A Bloomberg article summed up the worry:

A 75bp increase would be a communication shift for Jay Powell who has preferred to telegraph moves in advance and embrace gradualism. That strategy has allowed the Fed to lean in to tighter policy, but let markets price the risk of going faster or slower as the data rolled in.

A 75bp increase could though boost credibility by showing the Fed’s serious about its inflation fight. But it also risks confusing markets about what they do next if investors know officials are willing to switch guidance . . . 

A 75bp move could also erode Fed credibility by underscoring how poor the Fed’s forecasting has been in the post-pandemic recovery.

I think the answer to the first question is probably yes. It likely doesn’t matter when the market was surprised, given that almost everyone believes that it was the Fed that did the surprising.

You could argue that the market response would have been more violent if it got the news from the Fed itself. I’m not sure, though. Monday’s moves were pretty spectacular. The headlines would have certainly read differently. On Monday we got “Treasury yields soar on concerns Federal Reserve will raise rates sharply”, whereas today we would have gotten “Fed shocks markets with larger hike”. That difference might have had political implications.

Perhaps it’s dumb to have a blackout period at all. But none of this matters all that much, because the answer to the second question is no. The Fed’s credibility is not at risk here.

Credibility is what the Fed has when it can make the market believe it is going to do something just by saying it will do it. Clearly, in this case, the Fed had plenty of the stuff: markets thought it was saying a 75bp increase was coming, and the market immediately priced that increase in.

Credibility is a useful policy tool to have, so it is better, all things being equal, if the Fed does exactly what it says in advance it is going to do. But credibility cannot be sustained if the Fed mechanically sticks to old policies in the face of new facts. That would lead to the (true) belief that the Fed was run by nitwits. This is why Powell uses language like this, from last month:

What we need to see is clear and convincing evidence that inflation pressures are abating and inflation is coming down — and if we don’t see that, then we’ll have to consider moving more aggressively.

These are not weasel words. They are an expression of how sensible policy must work.

There is another concern about the 75bp move, which is that it might lock the Fed into a series of such moves, increasing the odds that the central bank will overtighten and drive the economy into recession. Here are Krishna Guha and Peter Williams of Evercore ISI:

The WSJ leak that the Fed will hike 75bp this week risks conveying a whiff of panic that the central bank thinks it is too far behind the curve, as to date there is no systematic and credible strategy behind the 75 . . . A 75bp move in June almost guarantees another 75bp move in July as little will have changed by then and risks the Fed being stuck in 75s for longer.

The problem is not the idea of a catch-up level-shift in rates — we first started talking about this in late ‘21 — but the combination of big increments and an outcome-based standard for stopping raising rates that looks like a recipe for going too far and causing recession.

First of all, it seems the Fed was not stuck in a rut of 50bp increases. Why would they be stuck with 75s? On top of that, Guha and Williams suggest that the Fed, in order to appear consistent, might pursue policies that are bad for the economy, and should therefore not pursue a policy that would be good for the economy without telegraphing it in a “systematic and credible strategy” — that is, saying what it is going to do, and why, in advance. But this is sort of bonkers. Credibility cannot be a justification for pursuing the wrong policy.

There is a real concern embedded in what Guha and Williams write. As Skanda Amarnath of Employ America recently pointed out, inflation lags economic activity. If the Fed keeps tightening until inflation appears totally under control, it will almost certainly tighten too much. If the Fed is not responsive and nimble in both directions, credibility will be the least of its problems.

One good read

In her triumphant return to FT Alphaville, Alexandra Scaggs asks why crypto exchange Coinbase had 20 times the staff of FTX, a similar-sized competitor. The tech rout, brutal though it may be, is reining in excess.

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