Great piece by Paul Wallace (Former Euro Economics Editor at The Economist) on Reuters.com today. Thought I’d share it and some of my thoughts as it’s on point with some of the main ideas that help guide my research.
First off, let’s be clear – I am not a “macro” guy. My thing is finance, financial economics, if you prefer. More specifically, informational financial economics and that’s why this post was so intriguing to me. Wallace dives right into it with his lead where he notes
After ingesting the Trump agenda and spitting out its market implications investors and traders can get back to their usual pastime: trying to work out what central bankers are plotting.
A simple statement of a dominant reality – the machinations of our monetary policy architects and overseers are a preoccupation of much of our investor class. It is the decisions and actions of this group of economic actors that helps to drive the global markets, of interest to everyone from a retired schoolteacher watching her pension to the President Elect of the United States.
Markets Hate Uncertainty
Reiterating the central premise of his commentary, Wallace talks about how Central Bankers have become “overly talkative”. He cites quotes from Fed Chair Yellen and ECB President Draghi as examples of commentary that has proven to be less than helpful.
All this chit-chat may be good for the cottage industry of highly paid central-bank watchers, but monetary policymakers have become too talkative for their and the wider good, sowing confusion and losing credibility in the process.
The irony here is that the very actions which were supposed to help stabilize the markets by providing clarity to investors are creating the opposite. Even more concerning is the fact that as communication becomes less clear, and therefore, less reliable as guidance for investing decision makers, the sources of those communication lose credibility. This can be a dangerous situation because there may be a time in the future when a Central Banker needs to call out a clear and present economic danger. Will the financial public heed the call, or will they, after years of “message fatigue” simply tune it out? Worse yet, will the public, guided by the pundits, try to parse the message and draw the exact wrong conclusion?
Back to the Future
Central Banker commentary is a relatively new phenomenon. I recall listening to the comments offered by Alan Greenspan and thinking that he had to be brilliant, because I could not for the life of me figure out if he was saying things were great, terrible or somewhere in the middle. Certainly his countenance offered no additional clues to the observer. Wallace notes that it’s been less than 20 years (since 1999 to be exact) since the Fed began offering statements following every meeting regardless of what, if any action had been taken in the meeting.
What drove this desire to share so much information? As Wallace aptly notes, citing the reasons behind the case for the new openness in central bank communication;
It formed part of a new model for monetary policy in which independent central banks sought price stability. In such a framework words count as much as deeds. They allow central bankers to mold expectations of future inflation, which feed back into actual inflation as businesses set prices and negotiate wages
The “echo chamber” at work. In this model, the bankers need the financial public to believe and act “as if” their plans for the future are going to happen. In so doing, they create the ultimate self-fulfilling prophecy. Notice the neat, almost cyclical relationship here – the Central Bankers issue communications which are correctly interpreted by their target audience, who then act in accordance with the expectations of the Central Bankers. This is challenging enough when the words/actions of the Central Bankers are being considered in real time. The complexity is amplified considerably when we get into the realm of future predictions, or “forward guidance”.
Forward Looking Statements
Most investors are familiar with forward looking statements and the accompanying legal disclaimers provided in conjunction with them. Publicly traded companies, by law (Securities Act of 1933 and Securities Exchange Act of 1934) must follow specific guidelines as to their communication with the investing public. The rules regarding forward looking guidance basically state that any such statements rely on information accurate at the time they are made, that circumstances and the company’s actions may change and there is no obligation or expectation that the company will update their communications to reflect those changes.
Central Banks and Bankers are under no such regulatory requirement. Further, as Wallace notes, forward guidance by Central Bankers goes beyond projections and moves dangerously close to the realm of promises. Wallace notes the dangers associated with this stance when he writes;
(F)orward guidance goes beyond hints about short-term decisions to explicit undertakings about the longer-term stance of monetary policy, including dates and thresholds for a critical gauge of the economy such as unemployment. Central bankers have overdone their attempts to talk their way out of an economic hole. Attempts to direct markets well into the future have lost credibility as policymakers failed to follow their own signals
Failed to follow their own signals? Faced with realities that diverged markedly from those they had themselves predicted several quarters prior, Central Bankers are forced to make changes to the models which they themselves had hoped to implement. The situation is exacerbated by the size of the Boards of the major Central Banks. There are numerous, highly educated, politically aware, opinionated men and women who make up these entities. There is bound to be differences of opinion among the members of this group. Unfortunately, the media spotlight may choose to focus on the most interesting, or well known of the group, and ignore comments from some of the quieter, more reserved members.
The last two decades have seen massive changes in the ubiquity and role of information in investor decision making. Chief among these have been the emergence of Central Bank guidance as a source of macro economic (inflation) information for investors. Wallace makes excellent points regarding the sensitivity of the investing public to Central Banker commentary, along with misguided attempts by Central Bankers to “talk the future into existence”. Ultimately, it may be too late to return to a time when Bankers were the unknown force behind the curtain, but efforts to increase the clarity of communications would be a welcome change for the investing public.