According to economists at Goldman Sachs Group Inc., the Federal Reserve just delivered one of its most dovish decisions of the new millennium.
The surprise, per Economists Zach Pandl and Daan Struyven, stemmed from the large reduction in where monetary policymakers expect interest rates to be at year-end if all things go according to plan. The median Federal Open Market Committee member thought that it would be appropriate for the midpoint of the federal funds rate range to be at 0.875 percent at the end of 2016, down from a median assessment of 1.375 percent back in December.
Excluding two meetings during the depths of the financial crisis in late 2008 and early 2009, the shock of Wednesday's slash to the so-called "dot plot" was only exceeded by introduction of calendar-based forward guidance in 2011, the decision to forego "Septaper" in 2013, and last March's markdown, according to Goldman:
"Markets had little doubt that the FOMC would leave the funds rate unchanged at yesterday’s meeting—futures markets implied only about a 5 percent chance of an increase before the announcement," wrote Pandl and Struyven. "Yet the decision was clearly a major dovish surprise for markets, with interest rates declining across the curve and the dollar falling against other developed market currencies."
The economists judge how big a surprise a Fed announcement is by the extent to which a variety of asset classes—from stocks, to gold, to inflation-protected Treasuries, to the Chicago Board Options Exchange Volatility Index—move together in the wake of these communiques, and the direction in which they go.
"If the central bank unexpectedly tightens monetary policy, nominal interest rates will tend to rise, but breakeven inflation and stock prices will tend to fall," the economists write, providing a theoretical example. "We can therefore infer something about the underlying macroeconomic shocks from the correlation pattern in markets."
On average, policy decisions have been more surprising following the financial crisis than the years that preceded it, write Pandl and Struyven. Given the introduction of unconventional monetary policy in the U.S. during this period, such an observation isn't too surprising.
But the pair also noted that Fed decisions accompanied by a press conference and release of updated economic projections tend to coincide with a larger degree of cross-asset correlation among their select variables than ones at which only a statement is released.
"The meaningful policy surprises in recent years are a puzzle in light of the large amount of information Fed officials now provide about their reaction function," write the economists. "One might have thought that the details provided in the summary of economic projections and through the press conference would have made it easier for investors to anticipate the committee’s response to incoming data."
On the other hand, when there's more information that investors have to anticipate—and more conflicting comments from monetary policymakers—ahead of these decisions, the scope for surprise inevitably grows.
This is a conundrum, to be sure, for a Fed whose attempts to increase transparency via tools like the dot plot have required monetary policymakers to explain, ad nauseam, the proper way to interpret these communication innovations.