Wall Street: Less Fed information will mean more volatile markets
Add Axios as your preferred source to
see more of our stories on Google.
Illustration: Eniola Odetunde/Axios
Less information from the Federal Reserve would likely make the markets more volatile and market pricing more "error-prone," Goldman Sachs chief economist Jan Hatzius wrote in a note Monday.
Why it matters: Markets won't stop trying to predict the Fed's actions in the face of less information — investors will likely make the same guesses, only with less evidence and a greater chance of getting it wrong, he argued, echoing the concerns of several other analysts and economists.
Catch up quick: Federal Reserve chair Kevin Warsh wants to reveal less about the Fed's "reaction function" — how the central bank connects economic data and news to its policy decisions.
- He wants financial markets to evaluate the economy directly — rather than through the lens of "what will the Fed do."
- That new strategy, on display at Warsh's press conference last week, didn't sit well with the bond market, as Axios' Neil Irwin explained.
Zoom in: Hatzius says markets will not stop trying to anticipate the Fed just because it's giving out fewer clues.
- "Participants in short-term interest rate markets—where Fed communication matters most—price what they think the Fed will do, not what it should do," Hatzius wrote.
- Without more information, markets will "have less information and potentially more inaccurate beliefs on which to base their thinking."
How it works: Hatzius sees two risks. Markets could underreact to a piece of data that matters to the Federal Reserve. That would delay the effect of monetary policy on the economy.
- Or markets could overreact to information that the Fed doesn't actually think is important — pushing interest rates sharply in one direction before reversing when policymakers fail to deliver the expected move.
Yes, but: The Wall Street Journal's editorial board argues that Wall Street should "quit whining about the Federal Reserve."
- The rise in bond rates that critics are pointing to could be due to other factors, they argue — like anticipated economic growth.
- Wall Street should do its job, the WSJ board wrote, and not look to "Daddy Fed."
Where it stands: Analysts now worry that the reaction function is harder to read — and Warsh's press conference last week intensified those concerns.
- The Fed held rates steady, as expected. But analysts say Warsh did not clearly explain the decision or spell out what economic developments would trigger a hike.
- Long-term bond yields and market-based inflation expectations rose, while stocks and the dollar weakened.
Bank of America economists said the reaction suggested investors were questioning the Fed's commitment to controlling inflation, rather than simply anticipating tighter policy.
- "It just added uncertainty," BofA economists Claudio Irigoyen and Antonio Gabriel wrote in a note late last week.
The bottom line: "If you give markets no information, they're going to do wild things," says David Kelly, chief global strategist at JPMorgan Asset Management.
- He agrees that Warsh's less transparent style has created market confusion and warns that cutting the number of Fed meetings would cause even more.
- "You know, if it ain't broken, don't break it," Kelly says. "There are lots of problems in Washington, D.C. The Fed's communications isn't one of them."
