Northern, WI  1/23/2012  (Streetbeat)  --  Starting this week the Fed is going to open up to the markets as it never has before. Four times a year they will shine klieg lights on their outlook for “the appropriate path for the FOMC’s target federal funds rate”, and, given that the economy acts according to the FOMC participants view of the best possible results, they will tell us when they figure the current rate regime will end and where the funds rate will eventually settle once the optimal outcomes for economic activity and inflation have been achieved. This level of Fed transparency is unprecedented; but, says the Fed, cue the director, we are ready for our close up. Only time will tell if the Fed can stand up to the scrutiny of this Hi-Def strategy, but it may be worthwhile to look back at the Fed’s silent era, to better understand the interplay of shadow and light and the advent of talkies in the conduct of monetary policy.

February 4, 1994 was a Friday. The FOMC was meeting that day, but so what? Yeah, I knew Chairman Greenspan had testified just a few days earlier, on Monday to be exact, before the Joint Economic Committee. And yes I was aware that he had offered a wink and a nod that the Fed may be ready to hike rates. And of course this would be a big deal if the signal turned out to be reliable. The Fed had not increased the fed funds rate in almost five years and they had not budged from their 3.00% target since September 1992 when they cut twenty five basis points off the rate to arrive at that level. But, I repeat, who cares? If the Fed was going to make a move on the funds rate there would not be any indication that they had done so until Monday at the earliest; Monday at 8:35am CST to be precise. There was no reason to delay your weekend planning with concerns about the Fed.

You see, that is how it was done. The Fed would discuss monetary policy with the curtains drawn. If they decided to alter the funds rate at their meeting they would indicate as much the following business day morning during “Fed time”, 8:35am in Chicago. So let’s say the target funds rate was assumed to be 8.00%; I say assumed because this was never explicitly announced by the tight lipped central bankers. But, if at “Fed time”, the rate was trading closer to 8.20% the market participants would pay close attention to the action taken by the New York Fed. If the Fed wanted to bring down the rate back to the supposed target they would add money to the system by doing something like an “overnight repo”.

If that was the case then everyone would acknowledge that the Fed was steady as she goes and return to their coffee and muffin. But if the NY Fed drained the system of some amount of cash through the use of “matched sales” when the funds rate was already trading rich, the market place was abuzz with the possibility that the Fed had just tightened policy and every tick in the funds rate would be put under the microscope to confirm or deny that the Fed moved. Proof positive might come after the close if the Fed had also decided to alter the Discount Rate, that’s because changes in this rate would always be announced through a press release. Of course none of this calculus was worth a dime on Wednesdays, which was bank settlement day and that meant the funds rate would trade so erratically that any Fed signal would be lost in the sauce, so don’t even bother trying to figure out the ingredients that moved the funds rate on that day of the week.

So on that Friday in early February 1994 there was more talk about the weekend than there was about the FOMC meeting, that conversation could wait.  “You got any plans?”…”the Fed just hiked rates!!!”…”Say what?!?”…”The Fed tightened!!”…”How do you know that?!?”…”They just said so!!”…”But they don’t ever say so!!”…”Read this.”

“Chairman Alan Greenspan announced today that the Federal Open Market Committee decided to increase slightly the degree of pressure on reserve positions. The action is expected to be associated with a small increase in short-term money market interest rates.

The decision was taken to move toward a less accommodative stance in monetary policy in order to sustain and enhance the economic expansion.

Chairman Greenspan decided to announce this action immediately so as to avoid any misunderstanding of the Committee’s purposes, give the fact that this is the first firming of reserve market conditions by the Committee since early 1989.”

Interest rate markets traded as though they were being chased around by the monster in a horror flick. For instance, the fourth Eurodollar contract didn’t know which way to turn for safety and established a fifty basis point range, four or five times the norm; trading as much as thirty-five higher before settling sixteen lower. The bonds were off a full point and the SP closed more than two percent lower on the day. A Fed spokesman may not have helped the transmission process when he explained that the announcement “stands alone and doesn’t mean we’re setting a pattern.” So was the Fed move a one off too? Oh, probably not. But one thing is for sure, no money left for this weekend.

The Fed also issued a statement confirming a rate hike following the next FOMC meeting in March. But this time it consisted only of a repeat of the first paragraph from the February release, but the market was on to the new chattier Fed style. You will note that neither statement actually indicated the fed funds target, which was still up to the market to figure out. The Fed moved inter-meeting in April and once again had the courtesy to announce it, but the statement was even briefer than the March missive. In May they also hiked the funds rate, this was a fifty basis point move, which was made somewhat obvious in their statement because they also moved the Discount Rate and acknowledged a move in that rate from “3 percent to 3 ½ percent”. There were more post meeting statements, but not every meeting generated official commentary; if they stood pat on rates they didn’t bother to report their inaction. It wasn’t until February 1995 that they began to issue a post meeting statement every time the FOMC convened, whether or not they took action.

There were other changes over the years to the way the FOMC described their policy stance in the post meeting statement. In May 1999 they began announcing their policy bias, indicating a “tilt” to their outlook. Although they “never offered a formal interpretation of the symmetry clause of its policy directive, the market interpreted the bias in one direction or another as an indication of the likelihood that the FOMC would change the intended funds rate in that direction” explained a St. Louis Fed paper, The FOMC’s Balance-of-Risks Statement and Market Expectations of Policy Actions. But this strategy was soon scratched because it made the market lean too far, in their opinion, in the direction of the “tilt” in anticipation of a move at the next policy session.

So in January 2000 they changed this practice and from that point forward included a “balance of risks” in the statement. “The balance-of risks statement was intended to indicate the Committee’s assessment of the balance of risks for heightened inflation pressures or economic weakness over the foreseeable future,” said the St. Louis Fed paper, “In announcing the procedural change, the FOMC explicitly noted that ‘this time frame in the new language is intended to cover an interval extending beyond the next FOMC meeting,’ suggesting that the balance-of-risks statement should not be interpreted as an indicator of the Committee’s next policy action.” It could be said the Fed never wanted to be seen as pre-committing to an action. Times have changed, don’t you think?

Now comes the next iteration of Fed policy communication techniques. As I said last week in this space, it is the Fed’s best guess on the future path of the funds rate acting as a policy tool. We shall see how this works. But I am already excited about the potential changes the FOMC will make in the future. I can almost imagine this news report; “Reuters, monitoring the FOMC twitter feed; #MonPol: cannot believe Chairman Trump is going to raise rates just because of bad hair day, vote in five minutes. @Fedgovernator.”