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The Death Knell of Forward Guidance: Fed Discards R-Star

  • ,  Chief Executive |
  • 02 Oct 2018
  • Updated 03 Oct 2018

Federal Reserve Doubles Down on Data-dependency

The death knell of forward guidance has been heard.  Recent comments by members of the FOMC have led economists to conclude that the Federal Reserve will no longer be guided by r-star; instead of aiming for a "neutral" rate of interest, they will rely on recent economic data to determine policy actions.  Tim Duy explains the two most significant implications of this decision, while the Brookings Institution expounds upon the benefits of this new monetary policy framework.  

Meanwhile, QMA looks into the possibility that inflation fears might be justified this time.  So, just where do we stand on the timeline that leads towards monetary policy normalisation, and how do investors avoid the Q-trap?  Read on to find out.

r-star forward guidance

The Federal Reserve’s “r-star” Has Gone Full Supernova (Tim Duy, Oct 2018)
NY Fed President John Williams made clear in a speech late Friday that the neutral interest rate is no longer a guiding star for monetary policy.

Rethinking the Fed's 2 percent inflation target (Brookings Institution, 2018)
In this paper, the authors advocate for a new monetary policy framework, stating that moving away from the Fed’s 2% inflation target allows for faster growth and lower unemployment.

Williams Calls for Gradual Hikes Amid Strong Growth Outlook (Bloomberg, Sep 2018)
Bloomberg provides a summary of the speech that NY Fed President John Williams Gave last week, in which he indicated significant changes to the Fed's views on both r-star and forward guidance as a whole. 

The Fed's GFC Swap Lines: Global Lender of Last Resort (PGIM, Sep 2018) 
(For compliance reasons, this paper is only accessible in the United States)
PGIM Chief Economist Nathan Sheets was actively involved with Fed policy during the heights of the GFC.  In this paper, he discusses the critical role played by Fed swap line arrangements in reducing systemic risk. 

Global Trends in Interest Rates (FRBNY, 2018)
Lower economic growth and other factors have propelled global real interest rates downward in recent years.  The Federal Reserve Bank of New York discusses trends in interest rates for safe and liquid assets.  

Help Wanted - Why U.S. Inflation Fears Might Be Right This Time (QMA, Aug 2018)
QMA’s analysis of U.S. economic data indicates a labor pool that is diminishing more rapidly than expected, a fact that has implications for U.S. investors.

Unconventional policy in the next downturn (LGIM, May 2018) 
(For compliance reasons, this paper is NOT accessible in the U.S. and Canada)
With interest rates still low across the globe, a lack of room to manoeuvre may force central banks to opt for more unconventional policy responses when the next recession strikes.

Video: Fed Delivers Next Hike as Economy Powers On (State Street, Sep 2018)
Chris Probyn, Chief Economist at State Street, ponders where central banks head from here, as the U.S. Federal Reserve continues its gradual tightening regime. 

The Fed's challenge: normalisation in the new normal (Hermes IM, Jun 2018)
Hermes Senior Economist, Silvia Dall'Angelo, discusses US monetary policy, quantitative tightening, normalisation, and the outlook for fixed income markets.

U.S. Economy in a Snapshot (FRBNY, Sep 2018)
This group of observations contains U.S. economic data through September 13, 2018, and was compiled by members of the FRBNY’s Research and Statistics Group. 

The Fed rate hike implications for bond portfolios (Capital Group, Sep 2018)
(For compliance reasons, this paper is only accessible in certain geographies)
Capital Group mulls over the recent Fed Funds Rate hike, the U.S. economic data underpinning this decision, and the potential implications for fixed income investors.  

Macro and Market Perspectives: Beware of the Q Trap (BlackRock, Aug 2018)
Although the Q Trap may make some intuitive sense (because QE has been good for risk assets, QT will be bad for risk assets), BlackRock warns that in reality this relationship is much more complicated.