For several months, I have pushed back against the market expectation that the Federal Reserve’s cycle of interest-rate cuts would start as early as March. Just last week, in an interview on Bloomberg Surveillance, I said that June was much more probable — both for when the easing cycle should start and for when it will start.
Accordingly, you would expect me to welcome Wednesday’s remarks by Chair Jerome Powell that a rate reduction in March is not the Fed’s “base case.” The problem is that this was handled in a way that unnecessarily robs the central bank of policy flexibility while lengthening the already long list of recent communication mishaps.
Let’s start with the signaling that followed the formal conclusion of a two-day meeting of the Federal Open Market Committee, the central bank’s policy-setting committee. It started, as usual, at 2 p.m. Washington time with the release of the committee’s statement. Carefully crafted, the statement maintained considerable policy optionality by, first, noting that the risks to achieving the “employment and inflation goals are moving into better balance,” and then stating that the committee “does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably towards 2%,” its target.
In the regularly scheduled press conference that followed, Powell maintained this optionality when he read his opening statement. He also stayed on script in responding to the first question on what policymakers need to see to gain confidence about sustainably meeting their inflation target, saying: “We do have confidence, but we need greater confidence.”
Pressed further by reporters, and now in unscripted mode, Powell suddenly removed this optionality by pivoting to much greater precision. He surprised many by explicitly stating that a March rate cut is not “the base case.” Markets responded by taking stocks notably lower, resulting in the largest daily loss since September.
I agree that, if the Fed is truly committed to its 2% inflation target, it would be prudent for its first rate cut to be delayed beyond March. As such, Powell is correct. The problem is how he chose to convey that.
The sudden pivot continues a recent history of inconsistent Fed communication. A study published in March 2023 by the Centre for Economic Policy Research concluded that “market volatility is higher during FOMC press conferences than at other times … [and] this has been true since 2011 but is especially the case for press conferences given by current Fed Chair Jerome Powell.”
It also found that, “before the Covid-19 pandemic, the press conference tended to reinforce the FOMC statement, with markets moving in the same direction during the press conference as they did when initially reacting to the statement. However, since the start of the pandemic, stock and bond markets have tended to move in the opposite direction during press conferences compared to their initial reaction to the FOMC statement. This reversal in direction is systematically linked to the words used in Chair Powell’s speeches.”
Both these outcomes have tended to persist since the publication of this study almost a year ago, fueling more complaints about Fed communication mishaps. It is a development that, if the Fed is not careful, weakens the power of forward guidance, an important tool in smoothing economic and financial adaptations to changing circumstances. It also helps explain the unusual and persistent refusal by markets to price in what the Fed repeatedly tells them about a policy tool that it fully controls.
Wednesday’s pivot fuels the debate on whether Powell is speaking on behalf of the committee or expressing his personal views — an issue illustrated in the past by the publication of FOMC meeting minutes that countered some of the content of his press conferences, causing avoidable market confusion and volatility.
When compared with the careful wording of the FOMC statement, the press conference pivot reduces the Fed’s flexibility should the economy slow faster than anticipated. After all, while the economy has continued to impressively surprise on the upside in terms of both growth and employment, some of the forward-looking indicators point to the need for caution in simply extrapolating this US exceptionalism.
Finally, there is the more controversial point. More economists are warming to the idea that 2% may be too low an inflation target for an economy subject to a less flexible supply side on account of both domestic and global developments. This is not to say that having consistently missed its inflation target in the last few years, the Fed should immediately opt for a higher one. That will not happen. But it is to suggest the importance of the Fed having flexibility in how it thinks about the journey to its longer-term objectives.
It is sometimes said that, when it comes to certain communications, less is more. In retrospect, I suspect this was the case with Wednesday’s Fed press conference. Reinforcing the well-crafted FOMC statement may well have been a better approach than the surprising and sudden provision of precision.
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