Last week the US Federal Reserve pulled an SBP on global markets. Just as the SBP surprised the markets with a rate hike after co-signing a LoI that suggested an ‘accommodative monetary stance’; the US Fed surprised the markets by deciding not to taper off the QE in September.
The Fed earlier said that QE would be tapered off by the end of this year; a time period which the market read as September, since October may have been politically difficult due to the search for Ben Bernanke’s successor.
In both cases the markets can be blamed for over reading the cues. Market men are quite famous for overreacting and following the herd. But, both cases also raise fingers at the respective central banks, for their failure to effectively communicate with the market to provide clarity (See BR Research story ‘Accommodative’ or not?’ published on Sep 16, 2013).
After the US Fed embarrassed global market pundits by not cutting back the QE, global financial media has brought some interesting critics forward.
“Why bother with transparency when you can – and do – change your mind,” one fund manager was quoted by the Financial Times. Another Goldman Sachs divisional head was reported to have said that Fed’s surprise raises the question of “whether markets will believe the Fed in the future as much as they have in the past?”
This comes in the backdrop of scholarly evidence which suggests that clear and effective communication can be an important and powerful part of the central bank. Gone should be days of esoteric communication.
A 2008 working paper published by US-based National Bureau of Economic Research (NBER) noted that central bank’s communication has the ability to move financial markets, “to enhance the predictability of monetary policy decisions, and potentially to help achieve central banks’ macroeconomic objectives.”
Recognizing the impact of communication on market stability and volatility, the US Fed initiated the practice of released minutes of decision meetings – a habit that the State Bank of Pakistan picked up in 2009 but gave away in 2011.
Despite doing away with that practice, the perception of SBP’s communication with the market to provide some sort of forward guidance has become better over time.
A BR Research poll of treasury bosses at banks and brokerage houses shows that the SBP’s communication is currently ranked at an average of 6 on a scale of 1-10, showing an improvement over their perception in 2007. The improvement is largely attributed to detailed monetary policy statements, data compendiums, and higher frequency of policy decisions.
By comparison, the communication skills of other central banks, polled by Barclays, have deteriorated.
The two polls are not exactly commensurable due to differences in poll size - BR Research poll is of fifteen leading players whereas Barclays’ poll is of 844 players worldwide. But, at least one message is very clear from the market: bring back the monetary policy minutes!
As for ensuring effective central bank communication, opinions at home and abroad converge on more transparency and forward looking guidance than less; and one reason for this view is that economic uncertainties of today are far greater than five or ten years ago.
The only problem is that the variation in communication strategies among central banks across the world implies that a consensus is yet to emerge on what really constitutes an effective and transparent communication strategy. Until then, the central bankers who are not sold on the idea of providing clarity will continue to have a field day of playing with the markets.
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