Data Dependent at Cost of Transparency
Data dependency is the Federal Reserve’s primary guidance at this juncture. Unfortunately, we have learned following the March FOMC meeting that Fed communication may be a poor guide to understanding their interpretations of that data’s monetary policy implications. The level of misunderstanding of the Fed’s interpretation of current and unfolding conditions was arguably greater than at any time over the last 5 years.
Former Fed Chairman Ben Bernanke once remarked that market movement following the FOMC statement release gives a good indication of how transparent the Fed has been. Using that as a measuring stick, the market clearly indicated that the Fed had not been transparent in their communications in the run-up to the March FOMC meeting. Not once in the last 5 years had the rolling 5th Eurodollar futures contract (then EDM6) seen as large a gain during the FOMC statement release session. In fact, there had never in the last 5 years been any instance prompting yields at that part of the curve to fall as much in one day.
Data dependency has always been a guiding principle for the Fed. During periods of policy transition from excess accommodation to lesser amounts thereof, a situation most anticipate we are on the eve of, the Fed can be expected to have waited long enough before initiating the removal of accommodation that there shall be a longer uninterrupted period of policy progress. Similarly, the Fed has shown a tendency to allow policy measures to eventually reach more restrictive levels from which a longer period of uninterrupted progress toward easier policy conditions result. It is during those two monetary policy regimes (easing and tightening) where periods of unexpected economic data are less likely to dramatically impact interest rate projections or other asset prices.
Currently, U.S. monetary policy resides in the valley between easing and tightening policy regimes and at this juncture, economic data offers its greatest market moving impact. At this time, an economic release like the recent disappointing employment report can have outsized impact on interest rate projections and asset pricing compared to the response a similarly surprising report might cause in the midst of a policy regime (tightening or easing).
There has been a significant reduction in the level of participation in the interest rate markets over the last month or so and this cannot be attributed solely to the reduction in participation by banks as this class of users has been quiet for some time. Instead, it may be the added confusion brought by the Fed which has prompted traders to refrain from active participation until such time as economic data more conclusively points to the need to ‘normalize’ policy.
At This Meeting
· In general, the Statement is expected to be largely unchanged from the March FOMC.
· The Statement may acknowledge the weaker March jobs number.
· It may also indicate that inflation has not fallen further.
· It may acknowledge recent weaker production data.
More useful information from this meeting will come from the April FOMC Minutes released on May 20th.