As QE Fades, Fed's Messaging Machine Bolstered By Press Briefings
Ben Bernanke faces the unenviable task of dialing back on quantitative easing, but the Federal Reserve chief does have one important tool his predecessors lacked: televised press conferences.
More than two years after Bernanke embraced the hour-long events as part of a revamped communications strategy, the central bank can now lean on these high-profile appearances as a way to massage its monetary-policy message to a jittery marketplace.
A new analysis by Deutsche Bank (NYSE:DB) concludes these press briefings “play an important clarification role,” revealing the initial market response to the Federal Open Market Committee statement has tended to be at least partially reversed during the press conference.
The press conferences “could very well become an increasingly important tool for guiding policy as the Fed finds it progressively more challenging to keep market expectations on track as they begin to make a fundamental turn in the direction of policy,” Peter Hooper, chief economist at Deutsche Bank, wrote in the note to clients.
Bernanke will likely use Wednesday’s highly-anticipated press conference as a way to shed light on just how soon he believes the Fed will scale back its $85 billion of monthly bond purchases, a program known as quantitative easing, or QE.
Mixed Monetary Messages
Uncertainty over quantitative easing has clouded market sentiment since Bernanke’s May 22 testimony to Congress, with conflicting messages emerging from the Fed on whether the economy is healthy enough to stand on its own two feet.
In the three weeks after the May Capitol Hill appearance, the Dow Industrials experienced seven days of 200-point swings, ending lower on five of those occasions. By comparison, the blue chips had just four such moves prior to May 22 for the entire year.
“I do expect Bernanke’s tone to be more dovish in the press conference. He will take pains to explain how tapering works, before explaining that we are not there yet,” Michael Block, chief strategist at Rhino Trading Partners, wrote in a note on Monday.
"If the Fed is unable to manage expectations effectively, their ability to achieve their targets for the real economy and inflation may be limited."
Nicholas Colas, chief market strategist at ConvergEx, said he doesn’t believe the Fed’s messaging arm has “stumbled,” noting that the VIX volatility hasn’t even returned to its long-run average.
“No matter what pathway they took, it was going to be hard to raise the topic,” he said.
Colas also noted that Bernanke, who may be in the final months at the helm of the Fed, has worked to boost transparency, especially compared with his predecessors who often left market participants in the dark.
“Bernanke is very different. We all scratched our heads at Greenspan and his sentences that would go on for paragraphs,” said Colas.
Dovish Bias Ahead of Press Briefings
Still, because monetary policy courses through the financial system via forward-looking interest rates and asset prices, it’s pivotal for the Fed to make its intentions as clear as possible to market participants.
“If the Fed is unable to manage expectations effectively, their ability to achieve their targets for the real economy and inflation may be limited,” Hooper wrote.
With that in mind, the markets do seem to respond differently in the days leading up to press conferences rather than the normal FOMC meetings. (Press conferences follow every other FOMC meeting).
While the S&P 500 tends to rise by about 1% more than average in the five days prior to an FOMC meeting with a press conference, it tends to fall about 1% more during the five days preceding a meeting that lacks a press conference, Deutsche Bank said. In addition to rising stock prices, the days before press briefings see declines in the VIX, dips in the dollar and shrinking interest rates.
“Markets anticipate that more significant policy moves will occur during meetings with press conferences,” Hooper wrote. “Press conferences afford a better opportunity to ‘explain’ a policy change in full, to reduce the risk of miscommunication and misinterpretation.”
Since these policy announcements, such as the unveiling of QE3, have largely been dovish since press conferences began in April 2011, the reaction in the marketplaces makes sense.
Easing Off the Easy-Money Pedal
Now that the Fed is starting to move towards scaling back easy-money policies, it stands to reason the central bank will begin that process during an FOMC meeting that includes a press conference.
Hooper said a tapering announcement is “much more likely” to come in September or December, FOMC dates that include press briefings, than in July or October. However, the Fed did announce several policy decisions on days when it didn’t meet with the press, including the shift to calendar-based guidance for the fed funds rate in August 2011.
It’s also interesting to note how the markets react on an intraday basis to the various components of Fed Day.
According to Deutsche Bank, the S&P 500 sees an average change of 0.20% after the release of the FOMC decision, but a 0.29% move after the press conference. The broad index moves just 0.11% during the introductory statement, which largely mirrors the FOMC statement, but 0.23% during the more informative Q&A portion of the press conference.
While the findings have a relatively small sample size, they do still highlight just how pivotal the Fed press briefings have become, with market participants around the world combing through each and every sentence from Bernanke and even paying close attention to his demeanor.
“All of us on the trading floor literally turn the volume up and watch every single one of them from beginning to end. We’re all looking at it in real time,” said Colas.