Yellen, Carney Face Explaining Policy as Benchmarks NearRich Miller and Simon Kennedy
Janet Yellen has some rewriting to do.
As she prepares to deliver her first testimony to Congress as Federal Reserve chairman, the central bank’s tactics for guiding the recently more turbulent financial markets need reworking.
Even as unemployment nears the 6.5 percent marker the Fed had set for starting discussions on raising interest rates, the central bank is still easing policy by continuing to buy bonds, albeit at a reduced rate.
“She needs to provide more clarity about what forward guidance is going to look like,” said Russ Koesterich, chief investment strategist at New York-based BlackRock Inc., which manages $4.3 trillion in assets. “There is some uncertainty about how the Fed is going to approach monetary policy.”
Yellen, who appears before the House Financial Services Committee tomorrow, isn’t the only central banker facing questions. Bank of England Governor Mark Carney has signaled he’ll update his guidance on Feb. 12 now that U.K. joblessness is brushing against the BOE’s 7 percent threshold to consider raising interest rates.
The success of their communication strategies has economic ramifications. If doubts surface about their intentions, confused investors, companies and consumers may hunker down, undermining the very expansions that Carney and Yellen are trying to spur.
While the Fed has signaled that monetary policy will stay easy for a long while, investors want it to spell out the conditions that would prompt it to shift its stance and begin raising interest rates, Koesterich said.
The recent financial tumult raises the stakes. Led by Reserve Bank of India Governor Raghuram Rajan, policy makers in emerging markets have complained that the Fed and other major central banks helped fan the turmoil by failing to account for the impact their policies have on other countries.
Investors in emerging markets and elsewhere had taken comfort in recent years from the belief that the Fed would aid the U.S. economy with quantitative easing at any sign of weakness.
With the central bank starting to moderate its monthly bond purchases, “the market knows it is not going to get that any longer,” Koesterich said. Now, “what the market is looking for are the metrics that will be influencing the Fed’s thinking” on when it will increase interest rates.
Federal Reserve Bank of Atlanta President Dennis Lockhart suggested on Feb. 5 that investors may not have long to wait to get a new message.
“When we get close to or even beyond the 6.5 percent, I think it is reasonable to expect the Federal Open Market Committee will revise forward guidance,” Lockhart told reporters in Birmingham, Alabama.
The increasing length of the FOMC’s policy statements illustrates how difficult it has become for the central bank to get its message across, said Torsten Slok, chief international economist in New York for Deutsche Bank AG.
When Yellen, 67, first joined the Fed board in 1994, the statement was 179 words long. When she returned to the central bank in 2004 after a stint in academia, it amounted to 278 words. The announcements grew longer after Ben S. Bernanke became chairman in 2006, as he sought to make the Fed more open. The Jan. 29 statement came to 830 words.
“It’s always been important to be clear about monetary policy,” said former Fed Vice Chairman Alice Rivlin, now a senior fellow at the Brookings Institution in Washington. “And the Fed has certainly come around to realize how important that is.”
The Fed and BOE are being forced to revise their forward guidance language because unemployment has fallen faster than they expected. When U.S. policy makers first introduced the 6.5 percent threshold in December 2012, they didn’t anticipate joblessness would reach that level until 2015. At 6.6 percent in January, it is set to break that benchmark this year, Slok said. Much of that drop has been driven by Americans leaving the workforce, rather than by companies hiring.
The jobless rate “is giving a seriously misleading reading of how strong the economy is” because of the contraction in the labor force, said former Fed Vice Chairman Alan Blinder, now a professor at Princeton University in New Jersey.
In the U.K., unemployment has fallen to 7.1 percent, just about the 7 percent focal-point set by the BOE last August. At that time, Carney and his colleagues on the Monetary Policy Committee projected their threshold wouldn’t be reached until 2016.
Bruce Kasman, chief economist at JPMorgan Chase & Co. in New York, sees both Yellen and Carney moving away from reliance on specific thresholds to a “more generalized” description of the variables affecting policy. The aim: to give themselves more discretion in setting rates.
U.S. policy makers already have de-emphasized the significance of the jobless marker. In December, they added language in the statement that they expect to hold the overnight federal funds rate near zero “well past the time” that unemployment falls below 6.5 percent.
Less specific forward guidance hasn’t worked in the past as investors doubted the Fed’s vague assurances it would keep policy easy, said Roberto Perli, a partner at Cornerstone Macro LP in Washington.
After the U.S. central bank reduced short-term interest rates effectively to zero in December 2008, it said it expected “exceptionally low levels” of rates to prevail “for some time.” Investors weren’t convinced and instead bet on higher rates in the futures market, Perli said.
It wasn’t until the Fed introduced much more specific guidance in August 2011 -- at the time it promised to keep rates very low “at least through mid-2013” -- that investors got the message, he added. It later extended that pledge to the middle of 2015 before adopting the unemployment marker in December 2012.
To sharpen its message, the Fed may focus more attention on inflation, which is below its 2 percent target, said Richard Clarida, executive vice president at Newport Beach, California-based Pacific Investment Management Co., which oversees $1.92 trillion in assets.
“That would be a way for the Yellen Fed to provide some pretty informative guidance to the markets,” said Clarida, who is a professor at Columbia University in New York.
Under the central bank’s favorite measure, inflation was 1.1 percent in December.
For Carney, the concern is that even with the strongest growth since 2007, the U.K. economy is still not robust enough to absorb higher interest rates and bets to the contrary in financial markets could hurt growth. The pound is near its highest in 2 ½years against the dollar and money-market futures point to a rate increase in early 2015.
Unemployment may have fallen because of poor productivity, which slid in the third quarter, and slack remains in an economy which, unlike the U.S., is still smaller than before the financial crisis. Annual pay growth held at just 0.8 percent in the three months through October, and households, banks and the government are still paring debt. Inflation also is back at the BOE’s target for the first time in more than four years and Carney laments demand from Europe remains weak.
The recovery “has some way to run before it would be appropriate to consider moving away from the emergency setting of monetary policy,” Carney, 48, said in Edinburgh on Jan. 29. He has said there is no “immediate need” to raise rates.
Having always stressed 7 percent unemployment was a threshold for debate and not a trigger for action, Carney is now set to overhaul guidance, something he introduced and then scrapped when governor of the Bank of Canada.
Among the BOE’s options are trimming the unemployment threshold to 6.5 percent or setting a timeframe for keeping rates low. It could also follow the Fed in better detailing the rate outlook of each policy maker, outline a broader range of variables to inform policy, or mimic Scandinavian central banks in publishing rate forecasts.
The flaws of tracking unemployment or a single indicator have now been exposed and policy makers previously questioned tying policy to the calendar.
While Kevin Daly, chief U.K. economist at Goldman Sachs Group Inc., says the use of Fed-style forecasts is attractive, officials have said in the past they are reluctant to predict rates and prefer collective judgments. That leaves him betting the BOE will widen its focus to more indicators with a greater emphasis on wages as a gauge of the economy’s health.
Such a stance would allow it to keep borrowing costs on hold until the middle of 2015, he said.
Rob Wood, a former BOE economist now at Berenberg Bank, said the central bank should let “guidance wither away” because there is no need for stimulus and changing the language so soon risks undermining its credibility.
“There’s a lot of similarity in the situation the Fed and the Bank of England find themselves in,” Kasman said. “They’re stepping away from their thresholds because they’re willing to test the limits on how far unemployment can fall” without fanning inflation.
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