Can Transparency Muddy the Waters?

A lesson The Fed is Learning


In 1995 I jumped head first into family life by engaging in a relationship that included two young children at the time. I am happy to report that as of now and 20 years later those kids have grown up to be responsible productive individuals. One of the reasons for this seemingly positive outcome is the great advice offered by those that had gone before me. One of those being my mother, who has always seemed to know the right thing to say at the right time – Thanks Mom.


One of those many pieces of wisdom came at a time when some major decisions needed to be made in the household and the outcome of the decisions had affects to not only my wife and I but the kids as well. As my wife and I were discussing different ideas with my mother, she took the time to remind us that in some instances it is best for the parents in the room to make a decision as opposed to being democratic and enlisting the ideas of the other family members. As she put it, “There are adult conversations and then there are conversations you include the kids on”. Her point was that sometimes by being democratic you create more uncertainty and fear and at times it may be best for an adult to make a decision and inform the family of what that is. In other words, there are times that transparency muddies the waters.

Interestingly, in the same 20 years I have watched the “Financial Adult” in the room – The Federal Reserve – do the exact opposite. Let me give you a brief history of The Fed’s communications over the past 20 years to prove my point.

It may come as a surprise to some, prior to 1995 The Federal Reserve rarely, if ever, publicized the changes it made to interest rates. Markets were left to figure out The Fed’s moves as markets unfolded. That is in stark contrast from today where The Fed not only announces it decisions but has press conferences around the decisions as well as issues forward guidance in the form of a statement that gets dissected by market participants to a granular level.

The transition has been interesting and entertaining to observe. In 1995 The Fed was chaired by Alan Greenspan who apparently understood that this new level of communication could have unintended consequences. So much so that he was more opaque with his style of communication by using phrases such as, “If I turn out to be perfectly clear, you’ve probably misunderstood what I said”. Throughout Greenspan’s tenure as Fed Chief he seemingly made great efforts to hedge his comments and to phrase his remarks carefully as he knew his words could impact markets.

Towards the tail end of Greenspan’s term there seemed to be a growing sentiment that The Fed needed to be more transparent and market participants were feeling like the children that never get to participate in the grown up talks and they were voicing their thoughts and whines. Ben Bernanke, Greenspan’s successor seemed to begin his tenure with this in mind as his style of communicating was much clearer (at least on the surface) and without all the wordsmithing we had come accustomed to during the Greenspan era. Then 2008 happened and like most crisis the calls for more transparency got louder. Shortly thereafter The Fed began the periodic press conferences that are now held after certain meetings.

As we enter a week when The Fed is poised to raise interest rates for the first time in 9 years, I wonder if we may be witnessing an important inflection point for The Fed and markets with these questions in mind.


1. Will all this transparency and effort to give forward guidance come back to bite The Fed?
2. Will there be an unintended consequence to this need for forward guidance in the form of a Loss of Confidence in The Fed?
3. Will the kids rebel and demand more?


For the last few months The Fed has been on a pretty serious speaking campaign talking about the possibility of raising rates and ending the conversation with the reminder that the decision is data dependent.

In September, The Fed sited the market volatility as one of reasons why they did not raise rates back then. In October, when markets rebounded from the August lows, The Fed removed that part of their statement. As a result market participants became even more confident The Fed will raise rates in their December meeting. Since then, market volatility has increased and the overall results of recent economic reports have been so-so at best. Will the Fed now back away from their recent posturing and not raise rates?

I will go on a limb and say that regardless of whether The Fed raises rates or not this week, the outcome will most likely result in greater damage to The Fed’s credibility. Something to be aware of as one Fed Chief once said:

“Fear and euphoria are dominant forces, and fear is many multiples the size of euphoria. Bubbles go up very slowly as euphoria builds. Then fear hits, and it comes down very sharply. When I started to look at that, I was sort of intellectually shocked. Contagion is the critical phenomenon which causes the thing to fall apart.”
-Alan Greenspan

 

The opinions expressed are those of Colby McFadden and Quiver Financial as of December 14, 2015 and are subject to change due to market or other conditions. This is not a solicitation or recommendation of any investment; always consult a Financial Advisor before investing into any investment. Securities offered through Newport Coast Securities, Inc. - Member FINRA / SIPC - Advisory Services Offered through Newport Coast Securities, Inc. 18872 MacArthur, 1st Floor, Irvine, CA 92612 - 800.992.5592