BRACE yourself for a big shift: Central banks are getting out of the crystal ball business. We are transitioning to a world where data, rather than detailed projections about the direction of monetary policy, is the key to understanding where interest rates are headed.
This marks a significant departure from a guiding philosophy that’s been around since at least the 2008 financial crash.
“We’re going to be guided by the data,” Federal Reserve (Fed) chair Jerome Powell (picture) told reporters after the Federal Open Market Committee wrapped up a two-day meeting on Wednesday.
“In fact, what I’ll say is that we’re going to be led by the incoming data and the evolving outlook. We’ll try to communicate as clearly as possible, moving steadily and transparently.”
This means central bankers’ success will no longer be determined largely by the ability to foreshadow their approach to managing borrowing costs several months or even years in advance.
The world of so-called forward guidance, a tool central banks had turned into an art form, has been deeply challenged by inflation that got faster — way sooner — than anyone expected.
No wonder folks at the Bank of England have been quiet in the runup to their February meeting.
Reacting to facts on the ground sounds sensible. The trouble is that it requires moving with alacrity, when warranted, which is in no small degree of conflict with the direction of communication since the 1990s.
The governing idea in the decades that followed has been that more talking and information is better than less.
That approach was an answer to the charge that monetary authorities were too opaque.
Indeed, inflation that behaved as predicted made speaking often pretty straightforward. But when circumstances are rapidly changing, as during the Covid era, this level of transparency requires either a confusing degree of opacity or the possibility of frequent flip-flops.
Powell said that risks to the economy are coming from two different directions, and he was correct.
The highly contagious Omicron variant is a threat to the labour market and, by extension, economic growth. Rapid price increases pose a different, but more significant danger, to the recovery.
Let inflation go too far, and the resulting crackdown might be too harsh, which could possibly curtail the expansion.
At a press conference after the decision, Powell was pressed on the likelihood of a 50 basis point increase in the benchmark rate and the chances of a nudge higher at every remaining meeting this year.
A hike is probably coming in March, was about as far as Powell would commit, other than doing what’s needed to quell inflation.
Investors, used to more visibility, have had trouble identifying when the legendary “Fed put” would kick in — the idea that the central bank would buckle if markets got too bruised by a hawkish stance.
In a way, such angst misses the point. The “put” was possible because a longstanding, benign inflation picture left the Fed free to respond to concerns about growth.
That world is gone. “Dovish guidance is being replaced by no guidance,” Krishna Guha, a former Fed official now at ISI Evercore Inc, wrote in a note on Wednesday.
Powell’s remarks about the need to be “nimble” have received a lot of attention. Getting less air time has been his comment about the need for “humility.”
This implies not being averse to admitting errors and, critically, doing something about mistakes. That may mean forceful actions when readings on inflation and jobs demand it.
This isn’t just an issue for the Fed. Soon after Powell left the podium, New Zealand reported that inflation jumped to 5.9% in the fourth quarter, faster than anticipated, and a considerable distance from the midpoint of the central bank’s 1% to 3% target range.
Further hikes from the Kiwis are a lock. On Wednesday, a top official at Indonesia’s central bank said he’s ready to strike.
“The principle we will conduct with is what we call a pre-emptive, ahead-of-the-curve, front-loading policy,” declared Dody Budi Waluyo, deputy governor of Bank Indonesia.
Next week’s focus will be on the Reserve Bank of Australia, which is likely to end quantitative easing and walk away from its insistence that interest rates are unlikely to climb this year.
There is enough humble pie to go around. Will that satisfy the cohort of central bank watchers used to being told what the Fed will do before the institution even thinks about it? Data-dependence often talked about and less seldom practiced, is about to get its first test run in a long time.
It’s hard to imagine that the Fed just walks away from the tussle with inflation. It surely has a lot more work to do.
With rising prices making front-page news, it’s fair to say the topic has gone thoroughly mainstream. — Bloomberg
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.