MacroScope

How big is the Fed’s communications gap? Six months, give or take

September 30, 2013

You have to give Federal Reserve Chairman Ben Bernanke credit for standing his ground on data-dependence. Despite widespread suspicions, including on this blog, that the central bank would begin reducing the pace of its bond-buying stimulus in September simply because the markets were expecting it, the Fed chose to hold off in the face of a still-fragile economy.

Here’s how Bernanke addressed the issue of the market’s surprise at the Fed’s decision at his press conference:

I don’t recall stating that we would do any particular  thing in this meeting. What we are going to do is the right thing for the economy. And our assessment of the data since June is that, taken collectively, that it didn’t quite meet the standard of satisfying our – or of ratifying or confirming our basic outlook for, again, increasing growth, improving labor markets, and inflation moving back towards target. We try our best to communicate to markets – we’ll continue to do that – but we can’t let market expectations dictate our policy actions. Our policy actions have to be determined by our best assessment of what’s needed for the economy.

Still, even some Fed officials themselves have by now admitted the central bank did a poor job in communicating its message to markets in advance of the last meeting.

So, how wide is the Fed’s messaging gap? To get a rough measure, we can look at how much market expectations differed from central bank guidance at various points in time.

The first major tapering-related move came in May, after three little words uttered by Bernanke – “next few meetings” – sent traders into a frenzy. Why did everyone freak out? At the time, the market had been counting on a taper start date of around December or even later. By saying next few meetings, Bernanke had suddenly put June on the table, an abrupt six-month recalibration.

Then in June, Bernanke gave a press briefing where he did little to dissuade the market of its newly hawkish expectations.

Fast-forward to September, where nearly all market participants were braced for a taper.  With the Fed’s decision to delay any cuts in bond-buying for now, the field of forecasts for when such a reduction will begin has again been torn wide open, with many economists now pegging March 2014 as a potential starting point.

“I think it could be even longer than that,” said Steve Wyatt, professor of finance at Miami University’s Farmer School of Business in Oxford, Ohio.

This means despite his best efforts, Bernanke may not be in office before the Fed starts to pull back on its extraordinary stimulus.

“We should not see tapering under Bernanke’s watch,” said Thomas Costerg, economist at Standard Chartered.

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