Yellen’s Delphic speech and the Odyssean FOMC guidance
Dallas Fed president and chief executive officer, Richard Fisher spoke at The Asia Society, Hong Kong on Friday, April 4, about “forward guidance” in monetary policy. The topic has recently became the focus of discussion in the US after the Fed’s March FOMC meeting, when the Fed decided to go with “qualitative” rather than “quantitative” guidance regarding future monetary policy statements. In this article, we’ll discuss how the Fed’s Odyssean and Delphic guidance in March has impacted financial markets.
How does forward guidance impact investors?
Market participants would prefer quantitative (Odyssean) over qualitative (Delphic) guidance, as it firms their expectations with respect to interest rates and inflation. As we mentioned in Part 4 of this series, the lack of volatility with regard to monetary policy has spurred examples of “irrational exuberance” in both stock (VOO) and fixed income markets (HYG).
Odyssean guidance at the March FOMC
At the March FOMC meeting, the 16 members of the FOMC provided individual forecasts on when they expected the increase in the Fed Funds rate and by how many basis points (or bps). Fourteen of the 16 FOMC members estimated a rate hike by 2015. Fed officials also revised their forecast for the median rate at the end of 2015 to 1% from 0.75%. Janet Yellen, at a press conference after the meeting, mentioned that the rate hike might occur about six months after the end of monthly asset purchases. This would imply that the most likely timeframe for the rate hike is Q2 to Q4 2015.
Reactions to the Fed’s announcements after the March FOMC
Markets fell after these announcements because the rate hike came earlier than expected and the Fed had also revised its base rate guidance upward by 0.25% at the end of 2015. The Vanguard S&P 500 ETF (VOO), which tracks the S&P 500 Index, was down 0.5% on March 19. VOO components Wal-Mart (WMT) and Exxon Mobil (XOM) fell about 0.5% and 1%, respectively. Popular fixed income ETFs the VanEck Vectors-Long Municipal Index ETF (MLN) and the PowerShares Insured National Municipal Bond Portfolio (PZA) were down 0.6% and 0.4%, respectively, following the Fed’s announcement.
Janet Yellen addresses “labor market slack” in a Chicago speech—an example of the Fed’s new Delphic guidance
On March 31, Yellen spoke at a community development conference in Chicago. She said, “This extraordinary commitment [monetary stimulus] is still needed and will be for some time, and I believe that view is widely shared by my fellow policy makers.”
Yellen further commented, “And based on the evidence available, it is clear to me that the U.S. economy is still considerably short of the two goals assigned to the Federal Reserve by the Congress,” referring to full employment and inflation. She also referred to various labor market indicators that suggested there was considerable “slack” or cyclical unemployment in the economy that would necessitate an accommodative monetary policy for some time.
Markets were most influenced by Yellen’s comments regarding the timing of the hike in the base rate. The Vanguard S&P 500 ETF (VOO), which tracks the S&P 500 Index, was up ~0.9% on March 31, due to prospects of extended monetary policy stimulus. Micron Technology (MU) was the day’s top performer, climbing ~8%.
So it appears that investors’ interpretation of the Fed’s guidance is the most influential factor that moves markets, rather than whether guidance is quantitative (Odyssean) or qualitative (Delphic).
To learn more about how investor expectations can sometimes influence economic indicators, please read the Market Realist series Why this week’s key releases seem more about expectations.