Must-know: Fed communicates intentions to the market



Who is Dr. Jeremy C. Stein?

Dr. Jeremy C. Stein is a member of the Board of Governors of the Federal Reserve. The other members of the board include Chairwoman Janet Yellen, Jerome Powell, and Daniel Tarullo. Dr. Stein joined the board on May 30, 2012. He has resigned from the board to return to a teaching position at Harvard University. The resignation is effective May 28, 2014.

Prior to joining the Fed’s board, Dr. Stein was the Moise Y. Safra Professor of Economics at Harvard University. From February to July 2009, Dr. Stein served in the Obama administration as a senior adviser to the Secretary of the Treasury. He also served on the staff of the National Economic Council. Dr. Stein’s past teaching assignments include a professorship at MIT’s Sloan School of Management.


On May 6, Dr. Stein delivered a speech on the “Challenges for Monetary Policy Communication” to the Money Marketeers of New York University.

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The Fed’s communication of its monetary policy to the market was remarkably unclear during much of its history. The situation started changing in 1990s when the Federal Open Market Committee (or FOMC) started providing timely guidance on its policy decisions. FOMC accelerated the release of meeting minutes, increased the frequency and scope of economic projections, and started conducting a press conference after its meetings to communicate the outcomes.

Despite greater openness in policy communication, markets usually experience volatility on otherwise clear monetary policy decisions. Dr. Stein discussed the following three main reasons why the communication, although clear, may not produce the desired results:

  1. The market is not a single person
  2. The Committee (or FOMC) is not a single person
  3. Interplay between the Committee and the market

We’ll be covering each of these challenges in greater detail in other parts of this series.

Why should ETF investors bother about monetary policy communication?

The Fed’s monetary policy communication is often perceived as the signal of economic conditions in the United States. When the Fed gives hints at an increase in interest rates, the equity markets (SPY) see it as a sign of an improving economy. For bond markets (BND), it is negative news because bond prices fall when there is an increase in interest rates.

During the press conference after FOMC’s March meeting, Chairwoman Janet Yellen said that the federal funds rate might increase roughly six months after the Fed ends its bond buying program. Markets perceived this as a signal of an earlier-than-expected interest rate hike. This caused yields across maturities to increase sharply and prices of popular bond ETFs such as the iShares 20+ year Treasury Bond (TLT), the iShares 7–10 year Treasury Bond (IEF), and the iShares 3–7 year Treasury Bond (IEI) fell.

To learn more about why yields increased after the announcement of the taper in the June 2013 meeting, even though market expectations remained the same, continue reading the next part of this series.


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