U.S. Federal Reserve Chair Janet Yellen is widely expected to raise interest rates this Wednesday, and Sauder PhD candidate Charles Martineau says his own confidence in that prediction isn’t just because of economic forces.
He recently completed a study on how the Federal Reserve rolls out monetary policy and found their public relations plan may be influencing the timing of high-impact policy announcements.
Why is the upcoming U.S. Federal Reserve announcement regarding monetary policy and interest rates expected to be significant?
For more than a year, economists have tried to predict the exact moment when the Fed will increase interest rates. Usually, economists rely on the employment data and other economic indicators to forecast the likelihood of an increase in interest rates. The recent economic data seem to indicate to economists that the Federal Reserve will increase interest rates on December 16 – the next Federal Open Market Committee (FOMC) press statement release.
But our research shows there is another indicator that economists are watching for when assessing the likelihood of an interest rate hike, and it has nothing to do with the health of the economy. Economists are getting tipped to the magnitude of what the Fed is doing if a press conference is scheduled to follow a FOMC press statement release from the Chair of the Federal Reserve.
What does a press conference say about the nature of the announcement and what might it say about what will happen December 16?
We find that if a FOMC press statement release is followed by press conference, markets expect important decisions to be made, and if there’s no conference they expect the status quo. The FOMC announcement of December 16 will have a press conference. The following meeting in January 2016 will not include a press conference. Hence, markets expect the increase in interest rates to happen this month and not in January 2016.
Press conferences were introduced in 2011 by the Federal Reserve to increase the transparency of the Fed’s actions and decisions. They are only held four times per year for half of the eight FOMC announcements. The press conference schedule is also known far in advance. This means that their occurrence does not depend on market performance.
Can this affect how markets react to announcements?
We find that if a press conference is scheduled to follow a FOMC press release, there is a significant increase in stock returns and a significant decrease in implied volatility following the announcement. There is no change in stock returns and implied volatility after the release of a press statement without an associated press conference. This shows the market expects announcements of key FOMC decisions only when a press conference is scheduled.
What are the potentially damaging effects?
Because the market only expects important decisions to be announced when there is a press conference, the Federal Reserve becomes constrained to follow expectations and limit their announcements of important decisions to only those with scheduled press conferences. Why? Because unexpected announcements can lead to turmoil in a marketplace. The Federal Reserve does not want to surprise markets during announcements with unexpected information. Unexpected moves can very often lead to serious and unexpected consequences. The result is that the Fed’s ability to introduce new monetary policy at a time of their choosing is substantially limited by the schedule of press conferences.
What do you recommend the Fed should do in light of your findings?
To do like the European Central Bank - have press conferences after every meeting, or simply cancel the press conferences. However, the last option will not be popular with those who demand more transparency from the Federal Reserve.