Don’t trade the immediate Fed trend

Ahead of the Federal Reserve statement and presser today comes a beautifully-timed paper from the Centre for Economic Policy Research’s VoxEU:

Market volatility is three times higher during press conferences held by current Chair Jay Powell than those held by his predecessors, and they tend to reverse the market’s initial reactions to the Committee statements…

This reversal in direction is systematically linked to the words used in Chair Powell’s speeches.

Perhaps shouldn’t come as a huge surprise that the Fed chair who presided over a global pandemic, and then the resulting rebound and inflation, has seen larger market reactions to press conferences than his predecessor:

But the study’s authors aren’t convinced Jay’s simply a victim of circumstance:

One explanation for the heightened market volatility during Chair Powell’s conferences could be the more volatile macro environment under his tenure, which includes the pandemic response and subsequent resurgence of inflation. However, there is no significant difference in market volatility across the three chairs during the placebo window, suggesting the heightened volatility during Chair Powell’s press conferences is not an artifact of higher baseline market volatility.

Of course, it could also be that heightened macroeconomic volatility (not market volatility) has simply made the Fed’s policy moves more important. That wouldn’t affect the market in the weeks leading up to a Fed meeting, but would bring greater volatility around the statement.

Powell’s press conferences also seem to have significantly more volatility than the statements:

One interesting point is that Powell also has held more frequent press conferences than former Fed chairs Janet Yellen or Ben Bernanke. It’s not clear this is a situation where the more data points would naturally cause a reversion to the mean, of course, but it’s worth noting.

So what does all of it mean? First, the press conferences are becoming more important, and probably by design:

These patterns indicate a shift in the role of the Fed press conference to one of growing importance – and not always as a straightforward reiteration of the FOMC statement. Such changes may be due course for a communication strategy that is always evolving . . . It is also possible that the press conference allows the Chair to emphasise his own views and get out ahead of other committee members – Meade (2005) and Gerlach-Kristen and Meade (2010) document strategies used by previous chairs to manage dissent – or to broach parts of the FOMC discussion not captured by the FOMC statement that the market finds consequential.

Whether that achieves the Fed’s goals is a different question altogether. From the authors, with our emphasis:

. . . deviating from the unified message in the FOMC statement and causing increased market volatility may be at odds with the Fed’s other communication goals. As explained by Alan Blinder (1998), “By making itself more predictable to the markets, the central bank makes market reactions to monetary policy more predictable to itself. And that makes it possible to do a better job of managing the economy”. Large fluctuations in stock and bond markets certainly seem incompatible with the goals of increasing predictability and reducing uncertainty. Indeed, we show evidence that recent conferences have been less successful at reducing uncertainty about the path of future interest rates, as measured using implied volatility of options on short- and long-term Treasuries.

A final possibility is that the goal of minimising market fluctuations is the wrong one. As Stein (2014) posits, a Fed that has “developed a reputation for worrying less about the immediate bond-market effect of its actions [...may] be able to adjust policy more nimbly when it needed to”. In other words, when the FOMC is learning about the state of the economy at as rapid a clip as today, perhaps a Fed Chair willing to jostle markets is exactly what is needed.

Find the full paper here.

Further reading
This particular Fed rule is still undefeated