Fed Chairman Powell hasn’t finished telling the markets where rates will go

WASHINGTON, July 26 (Reuters) – Since beginning its current round of rate hikes this year, the US Federal Reserve has been aiming to inform investors in advance not only where interest rates are heading overall, but also how much to expect move. every-time.

And despite some snags, including what analysts say was a last-minute change but successfully telegraphed ahead of the June meeting, Fed Chairman Jerome Powell is unlikely to abandon those efforts.

The Fed and other central banks have long used those signals — known as forward guidance in their parlance — to set expectations about the direction policy is heading to help create the financial conditions conducive to achieving their goal. Coming out of the 2007-2009 financial crisis, for example, the Fed set very long-term guidance ensuring that interest rates didn’t rise for years.

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Racing last year with the highest inflation in a generation has forced changes to that — in particular, shortening the horizon in which they can pledge certain actions.

“It’s a very difficult environment to try to give advance directive 60 or 90 days in advance,” Powell told a news conference after May’s meeting. “There are a lot of things that can happen in the economy and around the world. So, you know, we’re leaving ourselves room to look at the data and make a decision when we get there.”

Indeed, other central banks face similar challenges and are responding in new ways. The European Central Bank raised interest rates last week more than it promised at its previous meeting and did not provide guidance on the size of the increase next month. The Bank of Canada delivered a complete surprise rate hike earlier this month without breathing anything in advance.

But as the head of the world’s most important central bank now performs the biggest bout of policy tightening in decades, Powell has a vested interest in making sure markets don’t underestimate or overstate what’s ahead, analysts say.

On Tuesday, US central bankers began a two-day meeting in which they expect to approve a 0.75 percentage point increase, the two largest potential increases Powell said weeks ago were under consideration. Read more

Despite the uncertainty about what inflation and employment data will show in the next two months, analysts widely expect Powell to set some benchmarks around his September rate hike decision as well.

“Monetary policy works by market expectations, and if all goes well, you end up tightening more than you want to,” said Roberto Burley, economist Piper Sandler. “I think it’s a tough match, but I think it’s reasonable for them to play it.”

Larry Myers, the former Fed governor and now the Fed observer, says Powell may avoid on Wednesday a specific promise about the size of the next increase, but may take “any opportunity to leave the impression that it will be 50 or 75 ‘basis points'” to give markets an incentive to build at 100. “

He will also look for Powell to lay the groundwork for an eventual halt in interest rate hikes by discussing inflation “thresholds” that could slow the pace of tightening.

shocked the markets

The Fed began increasing its policy rate in March, raising it by a quarter of a percentage point, and noting that “continued increases in the target range would be appropriate,” a phrase most analysts expect to repeat this week.

Powell had indicated the volume of the March movement two weeks ahead of schedule, and similarly indicated, and then advanced, a half-point rise in May.

The pattern changed in June, when the Fed raised 75 basis points, although for weeks it had signaled a smaller rally.

But even then, markets were poised for it, thanks to an article in the Wall Street Journal less than 48 hours before the decision that indicated the possibility of a larger increase, given previous data that showed inflation and inflation expectations rose faster than expected.

The story was widely interpreted as a message from the Federal Reserve, which generally got high marks under Powell for its effectiveness in communications.

For Karim Basta, chief economist at III Capital Management, the last-minute switch was “suboptimal” and could have been avoided if Powell had not provided such specific guidance in the first place.

“It shocked the markets, it definitely shocked me, and again this is really unnecessary,” he said, adding that he would prefer Powell to stick to giving a range of rate hike possibilities — or say nothing at all.

This week’s rate hike will raise the Fed’s policy rate to what policy makers say is a “neutral” level, and further increases in borrowing costs are expected to drive economic growth and eventually inflation as well.

Tim Doe of SGH Macro Advisors is among economists who say the central bank’s delay in responding to rising inflation last year has forced policy makers this year to raise interest rates much more quickly than otherwise.

“They’ve fallen so far behind on data that it has become impossible for them to follow through on communications the way they prefer or want to,” Doi said. And it might not get any easier, especially when they decide it’s time to slow the price hike to a more regular quarter-point increase.

Doi said markets could react by spot pricing to lower interest rates, easing financial conditions and boosting demand before the Fed feels that inflation is convincingly heading lower.

“The idea that it would be a calculated pace of price hikes would be confused with a drive to cut — that is the communications challenge,” Doi said.

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(Covering by Anne Sphere) Editing by Nick Szyminski

Our Standards: Thomson Reuters Trust Principles.

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