Abraham Lincoln’s maxim, that it is better to remain silent and be thought a fool than to speak and remove all doubt, is one that some central bank policymakers might be advised to follow. The more they speak, the less financial markets understand.
According to Athanasios Vamvakidis, foreign exchange strategist at Bank of America Merrill Lynch, the drivers of currencies this year have been positioning, risk sentiment “and confusion about the central banks’ policy reaction function and doubts about the sustainability of their policies”.
Central bank communication, or miscommunication, is a running sore with investors. The US Federal Reserve has sought to guide markets and keep volatility contained. however a variety of views from officials often sparks bouts of market tension. This reflects the dominant role played by the US dollar and how swings in the reserve currency based on policy expectations ripples around the world, influencing the performance of emerging markets, commodities and other asset prices.
This week’s rate-setting Federal Open Market Committee meeting takes place yet again against the familiar backdrop of heightened market sensitivity about interest rate expectations.
Investors complain about the Fed’s mixed messages. On Friday September 9, hawkish comments by Boston Fed president Eric Rosengren sent the index that measures the dollar against its peers a third of a per cent higher. The following Monday, the market reversed after Fed governor Lael Brainard’s dovish remarks.
The Fed is overdosing on communication, according to Peter Rosenstreich at the online bank Swissquote. He says the central bank’s efforts at communicating its intentions have been revving up since the financial crisis, driven by a sense of responsibility to explain Fed policy more clearly and transparently.
“There is now an enormous amount of communication out of the Fed at random times that is really disrupting the market, and the situation has got out of hand. There should be a pullback on all of this communication.”
The Fed is not alone. Market scepticism about the Bank of Japan’s credibility, also meeting on Wednesday, has been influenced by policymakers saying a lot but acting little, the result being a strong appreciation in the yen.
The reputation of Mario Draghi, president of the European Central Bank, was similarly affected by last December’s decision not to take policy action despite strong verbal signals from ECB members beforehand, provoking a sharp move in the euro.
Mr Draghi tried last week to say as little as possible following the ECB’s no-change policy meeting, yet market reaction was largely negative.
Some other central banks get their message across more effectively, says Commerzbank’s emerging markets strategist, Peter Kinsella.
China’s policymakers “say what they do and do what they say”, he says, while Elvira Nabiullina, Russia’s central bank governor, wins his praise for allowing the rouble to float and conveying the need to use policy tools to bring down rampant inflation.
For Ugo Lancioni, FX and global fixed income portfolio manager at Neuberger Berman, the central banks that communicate effectively are that ones that do not trigger large markets swings, other than at times of major economic change.
But size is relevant. It is easier for central banks in the UK, Australia, New Zealand, Sweden and Norway to get their messages across, but then again they have limited impact on markets because their currencies and rate paths are “significantly impacted by the policies of the major ones”, says Mr Lancioni.
Better communication comes when there is an effective policy toolbox to use. As Ousmene Mandeng of EM investment fund New Sparta Asset Management says: “It is easier to communicate change than [to signal a] standstill, especially after a prolonged period of no change.’’
The Fed has been in “deep freeze” for about two years during which the balance sheet has been broadly stable, he adds, rendering it difficult to keep the market on its toes during such prolonged inaction.
Changes in the US economy appear to feed into market concerns that “the Fed has run out of ideas, if not also ammunition”, says Mr Mandeng. “Effective policy communication seems dead, and it is not clear to me that much can be done about it.”
Such inaction is causing market behaviour to change. So much data are known to the market and already discounted when central banks speak, says Mr Lancioni, driving investors to focus more on any hints about the future.
“The attention is all on the possible future path of monetary policy — and central bankers at the Fed, BoJ and ECB know that their messages can shape yield curve expectations and indirectly control currency behaviour,” he says.
One word sums up the reason for central bank miscommunication, says Charles Saint Arnaud, FX strategist at Nomura. “Unclear messages or a lack of commitment to a certain path are the result of central banks’ uncertainty: uncertainty regarding the outlook, uncertainty regarding the impact of their policies, uncertainty regarding the market reaction to their policies,” he says.
Then again, market confusion about central bank communication is nothing new. Former Fed governor Alan Greenspan came up with this memorable quote in 2007: “I know you think you understand what you thought I said but I’m not sure you realise that what you heard is not what I meant.”