Fed officials need to stop talking. Or at least dial it down.
Back in February, while calling for a “Volcker moment,” the incomparable Zoltan Pozsar suggested monetary policymakers were doing more harm than good while attempting to lay the groundwork for the first rate hike.
“Maybe FOMC members talk too much. They don’t keep the market guessing,” he said. By that he meant current FOMC members. Former officials, by contrast, can talk as much as they want. Or at least that’s the impression one gets from Pozsar’s habit of referencing Bill Dudley’s television cameos, quotes from which are a fixture of Zoltan’s missives.
Scornful jokes aside, Pozsar’s probably right about the frequency of Fed communications. Markets became addicted to forward guidance in the post-Lehman era, and as I never tire of reminding readers, it was forward guidance more than rock-bottom rates and asset purchases that underpinned the short vol trade in all its various manifestations.
At the ECB’s July meeting, Christine Lagarde jettisoned forward guidance and Jerome Powell followed suit the following week. But markets didn’t get the message. I talked about this at length in “‘Wrong’ Trades And Bad Bets.” The demise of forward guidance is designed to inject volatility or, at the least, it’s tantamount to removing a powerful vol suppressant. If you disavow forward guidance and risk assets rally, something’s gone awry.
Sure, it’s possible that markets were effectively front-running the assumed achievement of the Fed’s goals. That is, perhaps stocks rallied because the removal of forward guidance means the Fed is serious and the sooner inflation is under control, the sooner this nightmare will be over. But I don’t think that accounted for the lion’s share of the price action in the immediate aftermath of the July FOMC meeting (figure below). I think Powell inadvertently signaled to markets that the Fed would turn down the heat at the first sign of cooler price growth.
In February, Pozsar suggested the Fed could harness volatility in the inflation fight. “Volatility is the best policeman of risk appetite and risk assets,” he wrote, in the same note mentioned here at the outset. “To improve labor supply, the Fed might try to put volatility in its service to engineer a correction in house prices and risk assets — equities, credit, and Bitcoin too,” he said, adding that the surest way to achieve such an (un)controlled demolition is to withdraw transparency.
He meant that policymakers shouldn’t just stop listening to the market, but rather cut the market out altogether by, perhaps, doing away with press conferences, suspending the SEP and going into a self-imposed media blackout indefinitely. In such a scenario, policy decisions would be released on scheduled days, but they could come at any other time too, and Powell wouldn’t be “pleased to take your questions” following those decisions, because unless you intended to convey something about your own expectations for inflation and those of other people, nothing you might be wondering would be relevant to setting policy. That’s not a black box. Everyone would know what the inputs are: Inflation expectations and realized inflation. When the former are anchored and the latter near target, then, perhaps, policymakers might take a few questions here and there.
Of course, the Fed will do no such thing. Powell claimed to jettison forward guidance last month, but during the very same press conference, he made all sorts of forward-looking statements, some of which turbocharged a nascent rally in risk assets with the effect of easing financial conditions to the detriment of the Fed’s goals. That necessitated an exhausting week of additional banter from officials, all of whom sought to dissuade markets from trading a mistaken interpretation of Powell. It was absurd.
At the risk of lapsing into colloquialisms, this would be much easier for the Fed if they’d just shut up. It might not be easier for markets, and that would actually be an ideal outcome. Because it’s not supposed to be easy for markets. As Pozsar correctly assessed prior to the first rate hike, the whole point is to inject volatility. A lot of it. Deliberately. STIRs don’t set policy. Nobody elected Powell, but nobody appointed the S&P 500 to the Fed board either.
On Saturday, Michelle Bowman (who doesn’t speak very often), acknowledged that forward guidance was partly to blame for the Fed’s delayed reaction to rising inflation. “I am pleased to see that following the July meeting, the FOMC ended the practice of providing specific forward guidance in our post-meeting communications,” she said, in a speech at a summit sponsored by the Kansas Bankers Association. “I believe that the overly specific forward guidance implemented at the December 2020 FOMC meeting requiring ‘substantial further progress’ unnecessarily limited the Committee’s actions in beginning the removal of accommodation later in 2021,” she continued. “In my view, that, combined with data revisions that were directly relevant to our decision making, led to a delay in taking action to address rising inflation.”
And yet, they won’t stop talking. Not even on weekends. On Sunday, for example, Mary Daly showed up on CBS to “face the nation” and soothe frayed nerves among a citizenry suffering under the tyranny of double-digit grocery inflation. You’d think Daly might take a break from public speaking engagements. Just a few days ago, during a Reuters-hosted social media event, she rankled a perpetually irritable peanut gallery of finance-focused netizens with a remark about her own experience with inflation. So-called “Finance Twitter,” a community comprised of several thousand faux Libertarians who inexplicably have all day to spend on social media despite claiming, in their profiles, to manage lots of money (seemingly everyone on Twitter is “former Bridgewater” or “ex-Goldman,” a laughable charade born of Google searches for “biggest hedge fund” and “best investment bank” by people creating Twitter profiles), was aghast that Daly would admit to not being a regular at Dollar General.
Fast forward to Sunday, and Daly told Margaret Brennan that “if you’re out in the economy, you don’t feel like you’re in a recession.” She cited the labor market, and tacitly suggested there’s no wage-price spiral afoot.
Brennan asked how it was possible that economists were so wrong about July’s headline payrolls print. The economy added 528,000 jobs last month and not a single economist out of nearly six-dozen surveyed predicted a number above 325,000.
“You are a labor economist,” Brennan reminded Daly. “What was it that economists missed here?”
Daly, without apparent irony, said that while “it did surprise everyone who tries to figure out exactly what the number will be… I don’t think consumers or workers or businesses were that surprised.” She went on: “If you’re traveling anywhere [or] you’re just going out in your own community… there’s help wanted signs all over the place. People are can find multiple jobs if they want them.”
So, just to be clear, all labor economists needed to do in order to get a better read on what the headline payrolls print might’ve been was go somewhere. And not even very far, necessarily. Just anywhere. Just open the front door and walk down the street.
That’s an exaggeration, but Daly did seem to accidentally admit that economists are out of touch with their “communities.” That isn’t anything new, but it speaks both to the impossibility of forecasting economic outcomes and the hubris inherent in trying to do so. That hubris continues to manifest in predictions and pseudo-predictions which could prove disastrously wrong, but which the market will trade anyway, with feedback loops for a Fed which steadfastly refuses to — again — just shut up.
“It is going to take some time for the interest rate adjustments we’ve made to work their way through,” Daly told Brennan Sunday. Then, immediately: “And we are far from done yet.”
That raises an obvious question: If you don’t know how the changes you’ve already made will ultimately impact an economy that PhDs apparently aren’t spending too much time experiencing first-hand (relying instead on unreliable aggregates and compilations of survey anecdotes), how can you possibly know whether it’s advisable to keep going?
Oblivious, Daly pressed on. “That’s the promise to the American people. We are far from done,” she declared. The idea was to reassure households, but considering the Fed’s recent track record for forecasting economic outcomes, it could’ve been construed as an inadvertent threat. Something like this: “Oh, you thought 12% grocery inflation was bad? Well, we’re far from done with you. Next up is a recession. And you’ll love it too, because even though you won’t be able to afford groceries after you lose your job, your inability to buy food will make that food less expensive in a hypothetical situation where you’re employed again. That’s the Fed’s promise to the American people.”
Asked by Brennan if it “would still be appropriate to raise rates in September by half a percent?” Daly said “Absolutely.” Then she said “We need to be data dependent.” Then she said “It could.” Then she said “We need to leave our minds open.”
Yes, “minds open.” And please, for God’s sake, mouths closed.