Is the Federal Reserve the cause of the stock market volatility? Absolutely not. Well … maybe a little.
The “absolutely not” part is clear when we examine what the Fed statement said after its two-day meeting. The essentials were that the economy was still strong and growing, but at a somewhat slower pace. Inflation was low and within the Fed’s target range. The result, in monetary policy terms, was that the scheduled quarter point rise in interest rates would go into effect immediately, but next year’s schedule of increases would be cut in half to just two.
The stock market response was to post a significant loss.
Before we think there was a causal reaction, though, we should consider what likely would have happened if the Federal Reserve news release had said just the opposite — that the economy was slowing down and for that reason it was cancelling the planned interest rate increase. The market analysts would have read into it that we were headed for a recession and launched a major sell-off.
Still, if the Federal Reserve Chairman’s speech didn’t trigger the stock market’s subsequent loss, what did?
There seem to be two factors. The first is that investors were looking for a reason to sell. Despite the current strength and healthy growth of the U.S. economy, the drumbeats in the news media have been recession thematic so to some investors — and their algorithms — it looked like a good time to sell.
The second factor is that Federal Reserve Chairman Jerome Powell, who undoubtedly controlled the news release content, violated a long-standing rule of public addresses: “He speaketh muchly and too much.” We were getting too much information and the Fed was oversharing its uncertainties. There was no obligation to share the rationale for the quarter-point rate increase; it had long been on the schedule for December. The content of the statement, then, while intended to be reassuring to analysts and investors, instead read like an inventory of everything that could possibly go wrong in our economy — providing an already twitchy market with an excuse to pull back.
Was the Federal Reserve’s minor over-speak a major cause of the end of the bull market? Not a chance. Consider what the effect would have been if the central bank had taken the other route and given the market what it supposedly wanted. Suppose the Fed had released a statement that it would suspend its scheduled interest rate because the economy was slowing down and raising worries about a recession. There would have been a rush for the exits.
The reaction to the Federal Reserve’s statement was minor compared with the market plunge in response to the Treasury Department’s experiment in good intentions. Secretary Mnuchin, observing the market turmoil, telephoned the CEOs of the six largest banks to make sure they had adequate liquidity positions to weather the storm.
His action was understandable, if ill-advised. When word of this action got out, the market reaction was a collective, “Liquidity”? We didn’t know we had a liquidity problem. Things must be worse than we realized.” And Secretary Mnuchin’s efforts to reassure investors weren’t enough to stave off another stock price plunge.
There are two economics lessons in all this. The first is that transparency does not cure all problems. It solves some, certainly, but others are just rearranged. Some problems, in fact, may even be made worse by transparency. At least two stock market declines, so far, can be attributed to oversharing by the Federal Reserve and the Treasury Department.
The policy of transparency was adopted by the Fed years ago when uncertainty was believed to be encouraging market volatility and disruption. It is ironic that the same policy now could be responsible for spreading some uncertainty about the economy on its own.
The Federal Reserve should be reviewing its transparency policy to examine both its purpose and effectiveness. Do we, the public, really need to know, months in advance, the Fed’s intention to raise interest rates a quarter point? It seems possible that instead of serving the public, this level of transparence is playing a losing game of “never enough” in order to satisfy market players and their algorithms.
The second less is that transparency, if overdone, has the capability of revealing doubts and uncertainties to no positive purpose. Imagine, for example, if every platoon leader, sergeant and G.I. were fully informed of Gen. Dwight D. Eisenhower’s list of uncertainties and doubts that could lead the D-day invasion at Normandy to a disastrous outcome. We could have talked ourselves into a defeat.
The future is always uncertain. The whole idea of Federal Reserve and Treasury transparency should be rethought with the object of releasing factual information without adding to the uncertainty inherent in economic policy.
James McCusker is a Bothell economist, educator and consultant.
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