Years ago, people like me made a very good living forecasting all the monthly economic indicators, the Federal Reserve's balance sheet, and the Treasury's financing needs. We honed our analytical skills deciphering Fed policy, since the chair of the Fed never revealed his moves.
After the 2008-09 financial crisis, the central bank became more transparent. Fed Chair Ben Bernanke began holding news conferences and taking reporters' questions. He started publishing economic projections, in which each Federal Open Market Committee member expresses where he or she thinks rates are headed.
The need to forecast rate moves vanished. Fed watching was reduced to regurgitating: We could either criticize or justify the Fed's impending action, but we didn't need to predict it.
At the time, transparency around policy moves was justified as a way of reducing market volatility, and that looked to be true for several years. The market hardly budged when policy changes were implemented, since those changes were already priced in when the Fed signaled the rate moves in advance.
Even so, volatility wasn't totally avoided. The market responded violently when Bernanke signaled an unexpected major policy change in a 2010 speech at the Fed's annual Jackson Hole meeting, for example.
It gyrated again during the Covid-19 pandemic. In 2021, the market initially accepted Fed Chair Jerome Powell's description of inflation as transitory. Some argued that rates would rise again and the policy was wrong. But most investors had been lulled into thinking there was no point in positioning against the Fed since it wouldn't raise rates. After all, Powell himself told us that.
The markets trusted the Fed, and the Fed ended up getting it wrong.
Inflation proved especially sticky. The Fed needed to reverse course. To minimize the adverse reaction in the market, Powell hinted that only a few rate hikes might be needed. His effort to boil the frog-raise rates slowly at first-prolonged the market's adaptation to the need to normalize rates.
That slow change in policy also reflected the fact that the Fed had to reverse course by 180 degrees and acknowledge, if only implicitly, that its description of inflation as transitory was a major mistake. (At the time, some analysts did argue that the Fed was making a major mistake, but, again, this went against the Fed's transparent statements that they wouldn't raise rates or would only do so a few times.)
The Fed's behavior in 2021 was the exact opposite of its behavior under Fed Chair Paul Volcker. In 1979, Volcker recognized that rates needed to move up significantly to bring inflation to heel. Political pressures made it difficult for Volcker to take explicit responsibility for raising rates so sharply, so he instead moved to reserve targeting, absolving the Fed of responsibility for the huge increase in rates as a matter of policy. The Fed controlled reserves, not rates. The markets moved rates and Volcker didn't have to own up to the large rate movements that he had orchestrated.
Had the Fed been less transparent in 2021, the Fed-watching community would surely have paid far more attention to the data and recognized that inflation wasn't coming down quickly on its own. They would have concluded that low rates were stoking strong growth instead.
Some did make this case. But who really cared about the data in 2021? The Fed told us inflation was transitory. Fed watchers didn't do their jobs. Actually, their jobs had changed entirely by that point. Investors, for their part, were checked out.
Transparency came at a huge cost for the Fed. It locked the central bank into its policy statements and put the market to sleep.
Fed Chairman Kevin Warsh wants to undo much of the damage of forward guidance. He has set up a task force to review Fed communications this year, but he has already started saying less and making fewer prognostications.
It has been argued that, under Warsh, the markets will be flying blind without guidance, and that wild swings in the Treasury market, as seen after his July press conference, will become more commonplace.
That is possible. But it seems more likely that Fed watchers will adapt. They will have to: The Fed will no longer do their job for them. They must earn their keep. I bet they learn to do a better job of evaluating data and thereby provide better warnings to investors when policy changes are imminent.
Indeed, the market has seemingly already acclimated; even without overt Fed signaling that a policy change is coming, it is fully priced for a rate hike at Wednesday's Fed meeting, based on August inflation reports.
Unfortunately, forecasting is difficult for everyone-even for the Fed, despite its resources. It is especially difficult amid oil market volatility owed to conflict in the Middle East.
But the market shouldn't be forced to rely on the Fed's forecasting abilities for the sake of transparency. Nor should the Fed's reputation be so dependent on its ability to forecast. The acid test for the Fed is its ability to deliver price stability.
Guest commentaries like this one are written by authors outside the Barron's newsroom. They reflect the perspective and opinions of the authors. Submit feedback and commentary pitches to ideas@barrons.com.
The writer is managing partner and chief investment officer at Advisors Capital Management.
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