Since the US Federal Reserve started hiking interest rates this year, its aim has been to keep investors informed at all times. This means telling them just where their policy is heading and also informing them about the magnitude of the hike they should expect next. Even though there have been some snags, which include analysts saying that the plan was changed last minute before the June meeting, it is unlikely that chairman Jerome Powell is going to back out now.
The US Fed, along with the other central banks around the world, have used signaling, which they refer to as forwarding guidance, to establish expectations about the direction of their monetary policy. Their aim is to create the right financial conditions that can help them achieve their target.
For instance, when the central bank had come out of the financial crisis in 2009, it established long-term guidance that it would not increase the interest rates for years. That has had to change because of the massive surge in inflation that has been seen in the past year, which is the highest in a generation.
Moreover, it has also created an environment in which offering forward guidance has become immensely difficult. After the meeting of the bank in May, Powell said that giving guidance in advance for 60 to 90 days is becoming difficult. He added that there were too many things that could happen in the economy as well as globally. Therefore, they have to have some room to look at the data and then make a decision.
This is certainly the case because other central banks are also facing the same challenges and are using new ways to respond to them. The European Central Bank (ECB) had its monetary policy meeting last week, which saw the monetary authority raise interest rates more than it had said in the meeting before that. In addition, it did not offer any guidance about the size of the next hike either.
Similarly, the Bank of Canada also announced a surprise interest rate hike of 100 basis points earlier this month and it had not spoken a single thing about it in advance. However, Powell is heading the most important central bank in the world, which has begun its sharpest bout of interest rate hikes in decades. Thus, he has a big stake in ensuring that markets do not over or under-estimate what will happen.
Central bank meeting
On Tuesday, the US central bank is expected to begin its policy meeting, which will go on for two days. They are expected to finalize an interest rate increase of 75 basis points in the meeting. Furthermore, even though there is uncertainty about the employment and inflation data that will be seen two months from now, it is expected that Powell will offer some guidance about the interest rate hike in September as well.
He may not make a specific promise but is expected to give an impression to allow markets to manage their expectations accordingly.