What use is Forward Guidance that keeps being wrong?

by Shaun Richards

Last night brought one of the most anticipated U-Turns in monetary policy as the US Federal Reserve announced this.

In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate to 2 to 2-1/4 percent.

Thus we saw the expected interest-rate cut of 0.25% and there was also an accelerated end to the era of QT ( Quantitative Tightening).

The Committee will conclude the reduction of its aggregate securities holdings in the System Open Market Account in August, two months earlier than previously indicated.

Whilst we are on the subject let us use the words of the Clash as we may not see QT again and we certainly will not be seeing it for a while.

Yeah, wave bye, bye

At this point on a superficial level this looks like a success for Forward Guidance as the Treasury Note ten-year yield around the 2.04% level where it had started. But there are two big catches with this. The first revolves around when economic agents were making plans for 2019 because back then the Federal Reserve was talking of “normalisation” which involved 4 then 3 then 2 interest-rate increases in 2019. Now we have a cut and as I will discuss later am expecting another.

Last Night

The response of observers to the effort to provide new Forward Guidance by Chair Jerome Powell was to sing  along with The Strokes.

And say, people, they don’t understand
Your girlfriends, they can’t understand
Your grandsons, they won’t understand
On top of this, I ain’t ever gonna understand

Here via CNBC was his opening effort.

Looking at the history of the Fed, Powell cautioned against assuming that this week’s cut is the beginning of the cycles that happened in the past.

“That refers back to other times when the FOMC has cut rates in the middle of a cycle and I’m contrasting it there with the beginning of a lengthy cutting cycle,” he said. “That is not what we’re seeing now, that’s not our perspective now.”

So it was “one and done” was it? I doubt anyone including Chair Powell actually believed that especially if they looked at the knee-jerk response which was for a stronger US Dollar. Indeed in the same press conference he seemed to correct himself.

“Let me be clear: What I said was it’s not the beginning of a long series of rate cuts,” Powell said. “I didn’t say it’s just one or anything like that. ( CNBC )

He also managed to talk about interest-rate rises for a while as things got even more out of control. So you could have pretty much any view you like as we had guidance towards no more cuts,more cuts and perhaps rises too. That is quite a fail when the scale of your operations which already are the elephant in the room are about to get larger.

Oh and did I mention an elephant in the room?

What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world……..As usual, Powell let us down, but at least he is ending quantitative tightening, which shouldn’t have started in the first place – no inflation. We are winning anyway, but I am certainly not getting much help from the Federal Reserve!

That was of course President Trump who may tweet excitedly but so far has given us better forward guidance than the Fed. Who will bet against the US Federal Reserve making another interest-rate cut this year?

European Central Bank

The ECB has been on a not dissimilar road to the Federal Reserve. I am sure the “ECB Watchers” would like us to forget that they were predicting an increase in the Deposit Rate this year as a result of their inside knowledge. They of course ended up scuttling away into the dark but the ECB kept this up until the 18th of June.

We now expect them to remain at their present levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term.

The informal hint that a change was on it way provided by Mario Draghi on the 18th of June became formal a week ago.

We expect them to remain at their present or lower levels at least through the first half of 2020, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to our aim over the medium term.

So not as grand a scale as the Federal Reserve but up has become the new down here too, or to be more precise is on its way in September. Assuming of course this guidance is correct.

Bank of England

Governor Carney has been even slower on the uptake than his international colleagues. As 2019 has progressed and we have seen interest-rate cuts proliferate he has cut an increasingly isolated figure.

The Committee continues to judge that, were the economy to develop broadly in line with its May Inflation Report projections that included an assumption of a smooth Brexit, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon.

It is revealing that the sentence needs to be so long but the message is that the plan is to tighten monetary policy and apparently ignore the rush in the other direction. More realistically of course the reality is that we should be prepared for the return of the Unreliable Boyfriend as he has a track record of cutting interest-rates after promising rises.

Also this is revealing.

Mark Carney, Governor of the Bank of England says “there will be great fortunes made” for companies preparing for and tackling climate change. ( Channel 4 News)

These days he seems to spend much of his time discussing climate change. If we skip the issue of him having both no mandate and indeed no qualifications in this area we find that he is deflecting us from his troubles with monetary policy. From his personal point of view discussing it is also part of his application for the IMF job.

Meanwhile as we move through the “Super Thursday” procedure he constructed I hope the media will concentrate on how he is forecasting interest-rate increases in the current economic environment.

Comment

It is more than six years ago that Michael Woodford told us this.

Greater clarity within the policy committee itself about the way in which policy is expected to be conducted in the future is likely to lead to more coherent policy decisions, and greater clarity on the part of the public as to how policy will be conducted is likely to improve the degree to which the central bank can count on achieving the effects that it intends through its policy.

As you can see the initial point failed last night as Chair Powell was pretty incoherent. Whilst Mario Draghi of the ECB is a much more professional operator he too struggled at his last press conference on the subject of the inflation target. It is about to be Governor Carney’s turn to face the music and he is usually the most incoherent. This means that they cannot give the public “greater clarity” and in fact have misled them which means they are undermining their own policies.

Of course there is also the Riksbank of Sweden to make the others feel better.

Me on The Investing Channel

 

 

 

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