The Fed’s Bizarre Definition of “Transparency”

Photo by Alex Wong/Getty Images.

Wednesday was Fed Day in the US, with media falling all over themselves to front-run the announcement with previews and projections, prognostications and prescriptions. Most analysts foresaw the Fed deciding to keep the fed-funds target rate on hold at 0.25% - 0.50%. And they were right! That's what they did. But rather than close up shop and call it a day, pundits instead turned their attention to one of their most favorite-yet-misguided pastimes: Trying to divine when the Fed will hike by assessing the slew of words and data the Fed dumps on us in the name of transparency. We can't help but think this exercise confuses more investors than it helps, and the Fed could get a whole lot clearer by saying a whole lot less.

Now, the Fed has always been a somewhat mysterious body, and one whose power folks often overrate. As such, pundits and media types have long speculated about future policy direction. This is in overdrive in this expansion, though, as the Fed has been on a mission to bring "transparency" to its decisions and to give the market more information to set expectations for potential actions, lest they stoke volatility. This is why the Fed is in the practice of holding pressers these days. It is why the Fed employed what it called "forward guidance"-a means of setting market expectations for rate hike timing-after the financial crisis. And it is why Fed officials are constantly crafting messaging, like the January 2010 debate over whether to employ language stating that "inflation is likely to be subdued" versus "inflation is expected to be subdued." But this mission seeking transparency leads investors and pundits to the weird position of using these words to try to forecast Fed policy, which is literally impossible.

The Fed, for its part, seems to want to have this both ways. It wants to color fun pictures depicting the Federal Open Market Committee members' (FOMC, the people who set US monetary policy) forecasts like the two that follow this paragraph. Then it wants to use the press conference to tell you repeatedly why these don't amount to much, and that you shouldn't consider them a Fed forecast. March 2016 was a case-in-point. Exhibit 1 shows December 2015's dot-plot projection of FOMC member fed-funds target rate forecasts. Exhibit 2 is the one published Wednesday.

Exhibit 1: Dot Plot From December 2015 Meeting

Source: US Federal Reserve, as of 12/16/2015.

Exhibit 2: Dot Plot From March 2016 Meeting

Source: US Federal Reserve, as of 3/16/2016.

What do you see in these pictures? A bird? A cow? A horse with a hat on? The media answered this Rorschach test differently: They said it amounted to four minus two equaling about 1%.

Allow us to explain. The December 2015 dot plot, unveiled at the press conference held after the Fed's rate hike was announced, showed the 17 FOMC members' consensus view that the fed-funds target range midpoint would end 2016 at around 1.4%. Using the Fed's tendency to hike in 25 basis point increments, the media did some quick math and figured this meant the Fed was penciling in four rate hikes in 2016. Wednesday, however, the dot plot showed the consensus view now is fed funds will end the year at 0.9%, only two 25-basis point hikes from the present fed-funds target range's midpoint-two fewer than in December. Hence, four hikes minus two hikes equals about 0.9%.

But the Fed disagrees. When this meeting's chart was unveiled, Fed Chairwoman Janet Yellen was very careful to note that these are the individual outlooks of the 17 FOMC members-the median view shouldn't be taken as "the Fed forecasting X number of hikes between now and year end." She also went to great pains to explain, both in her prepared commentary and in the question and answer period, that monetary policy by nature cannot be on a "pre-set course" and will have to evolve along with ever-evolving economic conditions.

Yellen is right, of course. But the very fact she has to consistently remind pundits and reporters of this in Q&A and official statements should tell her this isn't a transparent policy. It is an extension of forward guidance, which was a lot like the Holy Roman Empire, in that it was neither forward-looking nor guidance. On December 12, 2012, the FOMC's official statement said fed funds would be at rock-bottom levels "at least as long as the unemployment rate remains above 6.5%." Six months later, Bernanke added more details, noting that 6.5% unemployment is a threshold for rate hikes, "not a trigger." Moreover, he added in the guidance that quantitative easing would likely end when unemployment was "in the vicinity of 7%." Three months after that, Bernanke dispensed with unemployment rate targets, stating that, "The unemployment rate is not necessarily a great measure, in all circumstances, of the state of the labor market overall."^[i] This is transparency?

Yellen has added her own foibles. At her first meeting in March 2014, the FOMC scrapped the unemployment target outright, as the rate had fallen to 6.7% and the Committee didn't want to send the message a hike was imminent. In the question and answer period, Yellen said the first rate hike would likely come "about six months or that type of thing" after quantitative easing ended, a statement she tried to walk back about as quickly as it left her lips. And nowadays, the explicit policy of forward guidance is largely a thing of the past, which we've allegedly exchanged for "data dependent" policy that is determined meeting-by-meeting. But the dot plot, data dump and verbal deluge remain. If this is transparency, we'd hate to see opacity!

We aren't usually ones to give the media a pass, but on this issue we're going to give them a break. After all, these folks are tasked with trying to decipher the Fed's message for John Q. Public. The Fed is to blame for this confusion, as its efforts at transparency utterly confuse the notion of "more words" with "clearer words." More isn't more clear. Fewer generally is. Clarity is a social matter, and if the vast majority of the Fed's audience isn't clear on what it means in its dot plot and words, then the Fed isn't clear by rule. Until such time as the Fed clarifies its messaging, we'd humbly suggest investors needn't pay it much heed.