Must-know: Janet Yellen’s take on the Fed’s forward guidance

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What’s forward guidance?

Central bankers usually provide markets with indications about their economic projections. They also provide information about their future monetary policy stance. Market participants watch forward guidance. Changes in the federal funds rate—central bankers’ main policy tool—can cause considerable movements in equity (SPY) (DIA) and bond (TLT) (IEF) markets. The Fed wants to reduce volatility (VXX) in markets by indicating its monetary policy stance. As a result, rate changes won’t surprise the markets as much.

Part 8

U.S. Federal Reserve provided forward guidance at September’s FOMC

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At its September Federal Open Market Committee (or FOMC), the Fed reiterated its stance that a “highly accommodative” monetary policy was in order. The FOMC statement also mentioned that the federal funds rate would stay low for a “considerable time” after asset purchases end. The end of monthly asset purchases will likely be announced at October’s FOMC meeting (refer to Part 2).

Credit conditions “abnormally tight”

Although economic conditions improved, consumption and wage growth were subdued. Speaking at the press conference after the meeting, Fed Chair Janet Yellen said that the labor market hadn’t fully recovered yet. She gave numerous references to her recent speech on the labor market at Jackson Hole, Wyoming. You can read about the speech here.

Credit conditions also remained “abnormally tight.” Credit was available to “pristine borrowers.” This was holding back consumer spending. Slow productivity growth was depressing investment spending. Consumption and investments are critical components for gross domestic product (or GDP) growth.

“Considerable time” implies data dependence

Yellen also elaborated on the “considerable time” theme at the press conference after the FOMC concluded. She pointed out that raising the federal funds rate wasn’t time-dependent. Instead, it was “highly conditional” on the state of the economy. Forward guidance that the Fed provided depended on data. It provided policymakers with flexibility to react to new economic data. She also said that there was “no mechanical interpretation” to forward guidance. There was “no firm promise about a particular amount of time.”

Two FOMC voting members didn’t agree with the Fed’s stance on forward guidance. We’ll discuss this in the next part of the series.

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